Thursday, December 27, 2012

Benefits trap art

Two charts from the UK, admittedly sprayed with too much chartjunk, but illustrating the poverty trap in Britain. (A previous post  on high marginal tax rates for low income people has more charts like this.)

Most of UK benefits are not time-limited, so people get stuck for life, and then for generations.

The original article, by Fraser Nelson, "Why the Poles keep coming" in the Spectator, is worth reading.  The article starts with the puzzling fact that
Britain’s employment figures are strong but most of the rise in employment so far under this government is accounted for by foreign-born workers (as was 99pc of the rise in employment under Labour). 
The author had the same epiphany that led me to economics all those years ago. No, it's not culture, or "laziness." Treat poor people as intelligent, responding to incentives, just like you and me, but with a lot bleaker choices. Try to look at the world through their eyes if you want to understand their behavior:
 if I was in a position of a British single mother I have not the slightest doubt that I would choose welfare. Why break your back on the minimum wage for longer than you have to, if it doesn’t pay? Some people do have the resolve to do it. I know I wouldn’t.
...Until our policymakers start to see things through the eyes of those ensnared in welfare traps, nothing will change. 
More great quotes:
If you had designed a system to keep the poor down, in would not look much different to the above.

...the cash-strapped British government is still creating still the most expensive poverty in the world.
Hat tip: Dan Mitchell writing at Cato@Liberty. His post is worth reading, as are the links. (Alas, the Spectator only cites the source of the graphs as " an internal government presentation," so I don't know who to properly credit.)


  1. One of the reasons immigrants come to the UK are precisely those generous benefits, most of which are not time limited, as you point out. They know about the benefits before they come. After working for a prescribed time, they become eligible to receive the benefits they would not receive in their countries. You claim that the benefits destroy incentives to work. This would be a good claim, if the unemployment rate were low. Are you implying that, if not for the generous benefits, nearly everyone would find a job? So what would be the real unemployment rate in the UK? My theory is different: The workers voted themselves those benefits so they would not have to work hard for low wages for extended periods of time. Again, fair distribution of profits. From an economic point of view it makes sense, as well. People, who receive the benefits, will spend them very quickly, increasing demand. An investor could invest the money which goes to those benefits, or she could save it. Workers spend what they earn (Kalecki). Unemployment rate in the UK is 7.8%. In the US it is pretty much the same but benefits here are far less generous.
    Germany has very generous benefits as well and the unemployment rate is 5.4%. And Germany is a highly regulated society with high taxes. Taxes in the UK are also high. Care to explain?

    1. Are you implying that, if not for the generous benefits, nearly everyone would find a job?

      The point is that if you get the same benefit from 6 hours of work or 12 hours of work, most would choose 6, since we tend to think there's disutility associated with labor. Is this controversial?

      Again, fair distribution of profits.

      What is a fair distribution of profits?

      People, who receive the benefits, will spend them very quickly, increasing demand.

      1. Where do the benefits come from? If taxes, then someone payed the taxes - net effect is zero. If from debt, someone else did not borrow and spend - net effect zero.

      If were in a supposed liquidity trap, then there's a bit more to discuss, but without getting into it, I'd still claim you're not getting any positive effect (in my opinion, negative).

      2. With fewer people working real output is lower. Depending on how we model the returns to labor, this could potentially mean lower output per worker than in the counter-factual.

      Unemployment rate in the UK is 7.8%. In the US it is pretty much the same but benefits here are far less generous.

      First, the US is also suffering from an incentive structure generated by relatively generous unemployment and disability programs.

      Second, I don't know how the UK calculates unemployment, but if it's like the US, then I imagine a lot of the individuals not working are not "looking for work" and so would not be classified as unemployed. As a result, you don't really learn anything by looking at the unemployment rates you specified.

    2. You covered so many topics that it would be impossible to answer everything, but I'll point out the main mistake you made.

      Superficial analysis of the unemployment rate is hardly convincing, and at worst misleading. Here are just a couple of reasons why, all of which off the top of my head. The unemployment rate measures unemployment based off of whether people are actively searching for work. Here's the EU: "unemployed as those persons age 15 to 74 who are not working, have looked for work in the last four weeks, and ready to start work within two weeks". So, if you absorb benefits and don't work, you aren't counted in the statistics. Not to mention that most countries, especially Scandinavian ones, have a tendency to count people in Labor Market Programs as employed, even if they aren't working at all. Essentially, they do this to hide the true unemployment.

      But there's much more. For example, the disincentive effects of different unemployment benefits, welfare programs, marginal tax rates, etc., have two employment effects in which either 1) people work more or less, or 2) people stop working or choose to work. You're only taking into consideration the second effect by looking at the unemployment rate, which misses probably the largest portion of the debate.

      Another example is that the unemployment rate takes into account absolutely everything unrelated to marginal tax rates, welfare, etc., but still related to the amount of people employed. If country A has a terrible drought, but less generous welfare policies, and country B has no drought, but generous welfare policies, what good would looking at the unemployment rate be? There's an omitted third variable that's completely unaccounted for. In the real world, there's a much larger amount of omitted third variables.

      In summary, if you want to convince people that your policy prescriptions aren't disincentivizing, then look at the microeconometric data instead of useless aggregate data. However, if you did that, then you'd be up to date on the overwhelming empirical evidence that they do, in fact, have disincentivizing effects.

      As for the rest of your comment, especially the " People, who receive the benefits, will spend them very quickly, increasing demand." statement, I'm not getting tangled in that mess. Not this time.

    3. Of course! You have opened my eyes, There is no such thing as disincentive! Now all we have to do in the USA is to double all unemployment and welfare benefits, and make them permanent. And quadruple all taxes!

      Then we will be rolling in prosperity.

  2. Mr. Cochrane: How about a nice post -- for us non-economists -- outlining your view on whether a safety net is desirable, and, if so, how it can minimize perverse incentives.

    Regards, Mark Jenkins (who confesses to being an attorney).

  3. The problem with the benefits trap logic is that it assumes that the ladder has only two rungs, welfare and working poor. In that case, the trap is indeed real. However, the ladder looks more like this:

    welfare, working poor, lower middle class, middle class, upper middle class, rich, very rich

    so a rational person who is on welfare should realize that even if there is a trap to go from welfare to working poor, it is the only way if you want to keep climbing the ladder to lower middle class or middle class.

    That's why in reality the trap is less of a problem than John presents it to be. It requires that a person be so incapable that they don't even entertain the idea of climbing the ladder. Unless you are disabled or retarded it's not clear why that should be the case

    1. And yet people do make that decision to just stay in poverty, in the millions.

    2. that's because we have lots of disabled and incapacitated people due to crime, drug abuse, gun violence and undereducated people due to lack of investment into early childhood education.

      so this calls for MORE welfare not less. The key is, which way does causality run?

    3. simple example:

      a woman takes care of her elderly father, but is unemployed, so gets many benefits from the state.

      she would like to work. however if she chooses to work, must put her father in a nursing home or hire a full time nurse. this will cost her directly something like 15-25k a year.

      she will also lose all her benefits. she must find a 50k year job (which she is not likely to find) in order to break even with not working.

      that is a poverty trap.

      more complicated example:

      individuals and companies for whatever reason underinvest in human capital.

      hence they are not looking at the long horizon return of making it to middle class when they fail to learn algebra in an abysmal southside Chicago school.

    4. im pro adding more early childhood investment, but i wouldnt call that wellfare ... and frankly paying people more food stamps doesn't seem like a good replacement for education ... do you think that giving drugdealers money is a good way to reduce violence?

      you must have switched definitions of wellfare on us ...

  4. If you pay people to be poor, you get more poor people.

  5. Back to milton Friedman's idea of a minimum income, which could be designed in such a way to ensure marginal tax rates never rose above, say, 40%.

  6. Until our policymakers start to see things through the eyes of those ensnared in welfare traps

    But you reject the only solution to the problem which is raising taxes on the wealth and maintaining and increasing benefits, even as one works more and earns more

  7. I think we often lose sight of something, which is that these people just want the most they can get for themselves and their family. If you can get X amount of money in benefits not working, vs. a lesser amount from working, you've created a situation where in any given period of time, the incentive is against work. Yes, it's true, in the long run, you might be able to become more skilled, move up the pay scale. But that's a really big if, especially when you're looking at a group that is generally low on skills, and the jobs that are available, such as retail clerk, don't have very much upward mobility. So as an everyday person, are you gonna give up benefits that are a sure thing to spend 40 hours a week working an entry level job, hoping that a few years of hard work will get you to an income somewhere above the total benefits you had? There are people who have a sense of pride and will want to take the hard path, but I think it's clear that these disincentives do have an effect.


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