August 25, 2020

Addressing Unemployment in the Pandemic

By Prof. David M. Frankel

A huge social issue right now is how to help all of the people who are out of work, by no fault of their own, as a result of COVID-19.

To organise our thoughts about this complex problem, let’s think about the following simplified version of the Australian (or any) economy: workers sell their labour to firms, which use this labour to make goods and services that the workers, in turn, buy with their wages.

Into this well-oiled machine, let’s now toss the “wrench” of the pandemic. As a result of COVID-19, fewer folks are going to offices, restaurants, bars, movies, theatre, sports events, travel, and so on. This means that the workers whose labour is typically used to provide these services no longer have income with which to buy the goods and services that they need.

The economy is still producing enough goods and services for all of us to survive. It’s just that the folks whose labour produces public consumption and office services can no longer afford the goods and services they need.

Society needs to find a way to supply goods and services to these folks so they can get through the pandemic. This will be costly. Where to get the money? And how precisely to spend it? Let’s begin with the first question.

Funding Options

There are three main ways to pay for support for the newly unemployed, each with its own costs and benefits. As my discussion indicates, I think that borrowing should be the first resort, followed by higher taxes and helicopter money in that order.

1. Borrowing

First, the government could fund payments to the needy by borrowing (selling bonds). This shifts the burden to future generations, who must repay the debt via higher taxes. Selling bonds will also lead to higher interest rates. This will depress private investment, thus inducing the economy to produce more consumption goods and fewer investment goods (plants and equipment). As a result, future economic growth will be slower. In short, borrowing will fund current consumption out of future consumption. This is likely the best response to the recession, so we prefer it.

2. Higher Taxes

Alternatively, the government could fund the payments by raising taxes. We focus on labour income taxes, which are most targeted towards those who can afford to pay – a critical issue in the current crisis. Such a tax rise would shift consumption from the still-employed to the unemployed. Unlike borrowing, it would not crowd out private investment and thus would not affect future growth. However, it would create a disincentive to work and thus depress current GDP – making the recession worse. Thus, higher taxes are an inferior option for countries, like Australia, that have low levels of public debt and so can easily borrow more.

3. Helicopter Money

Finally, the government could simply print money and distribute it to the needy. This is also known as “helicopter money”. By cheapening the value of the dollar, this policy would act like a tax on dollar-denominated assets such as pensions, bank accounts, bonds, and annuities.

Another cost of printing money is higher inflation. This effect may not be immediately evident since the pandemic has caused the employed to save more than usual. But it will emerge later when spending picks up – unless the Reserve Bank quickly sucks money out of the economy.

Helicopter money would also require unprecedented coordination between the Reserve Bank and the Treasury, which might damage the Reserve Bank’s reputation for independence.

Because of these concerns, helicopter money should be a last resort. It is likely not needed in countries like Australia that have low public debt and relatively low taxes.

[While I have written a prior blog post that is more positive on helicopter money, it did not do a systematic comparison to the alternatives. Helicopter money is indeed better than nothing. But it is likely inferior to borrowing and higher taxes.]

Unemployment Payments vs. Job Training

We don’t know how long the pandemic will last, so a serious effort at retraining the unemployed is also needed. This will help improve the mental health of affected workers and lessen their burden on the welfare system. The JobTrainer program is a good first step, but the jury is still out: in time, we may see that a more ambitious program is needed.

On the other hand, you can’t eat training, and training does not pay the rent. Thus, direct consumption support such as JobKeeper is also needed.

Cash vs. In-Kind Transfers

To provide consumption support, either cash or in-kind transfers can be used. JobKeeper is an example of the former. In contrast, in-kind transfers are funds that must be spent in a particular way; food stamps, rental vouchers, and subsidized job training (discussed above) are common examples.

In-kind transfers create a natural screening device, in which only those who need the service will apply for it. But in-kind transfers do not cover “miscellaneous expenses”, so they cannot completely replace cash.

Accordingly, we need a mixture of job training (JobTrainer), cash transfers (JobKeeper), and in-kind transfers of consumption goods and services (not yet widely used).

Loans vs. Grants

What about using loans rather than grants? Loans are certainly an option for job training, which raise the recipient’s ability to repay later. Also the need to repay the loan creates an incentive to find a job in which the training can be put to use. Finally, if a recipient has to pay something for her training, she might value it more and thus get more out of it.

On the other hand, we want to encourage the unemployed to take up training rather than relying on unemployment payments. Thus, training should be heavily subsidized but not provided entirely for free, with the worker’s portion deferred until she finds gainful employment.

Finally, consumption support for the unemployed should take the form not of loans but rather of cash or in-kind grants as the duration of the pandemic is highly uncertain and retraining will not work for everyone.