Welfare reforms and unemployment benefits are politically contentious issues – in Germany, for example, in connection with the Hartz reforms, and similar debates exist in Austria and many other countries. The effects of such reforms are often portrayed as straightforward: lower unemployment benefits increase the incentive to take up jobs, which should be good for the economy. However, this view ignores side effects that can play a crucial role.

A team from the European University Institute (Italy), York University (Canada) and TU Wien has developed a macroeconomic model that makes these indirect effects visible. Calibrated using data from Germany, the model shows that benefit cuts – such as replacing “Bürgergeld” with a stricter “Neue Grundsicherung” – do indeed reduce unemployment, but also have important negative economic consequences. Likewise, shifting the tax system toward a less progressive structure, as in the United States, would also create problems.

The model

“Our model captures realistically how people behave,” says Nawid Siassi from the Institute of Statistics and Mathematical Methods in Economics at TU Wien. “They search for new jobs, move up the career ladder, negotiate their wages, and save to protect themselves against risks. At the same time, firms decide on investments and job creation.” By combining these mechanisms with well-established econometric data, the model can be calibrated to quantify how different effects interact. This makes it possible to estimate the real consequences of policy reforms.

“Workers with higher wealth can afford to be more selective about the jobs they accept. Those close to retirement have less incentive to search for better positions. Our calibrated model reproduces these patterns,” says Nawid Siassi.

More jobs – but less prosperity

What happens, according to the model, if unemployment benefits are cut by, say, 10%? “Employment does increase, as policymakers intend,” explains Nawid Siassi. “The effects are quite substantial: more jobs are created, and more unemployed people accept positions they would previously have turned down.” But there is also a downside: average labour productivity declines, because workers accept lower-quality jobs. Average wages fall, and income inequality rises significantly.

“Despite higher overall output and employment, a worker entering the labour market faces a welfare loss equivalent to about 1.3% of lifetime consumption,” says Nawid Siassi. Younger people may benefit more from increased job opportunities, while older individuals are more strongly affected by the overall decline in welfare.

A flatter income tax

The model is also used to examine a reform of income taxation: reducing progressivity to roughly US levels while keeping total tax revenue constant. This implies lower taxes for high earners and a relatively higher tax burden for lower incomes. As a result, low-productivity jobs become less attractive, employment declines, and while average productivity increases, overall economic output falls. This, too, leads to a welfare loss.

What policymakers should take away

“The reform debate often focuses on employment and fiscal effects – but that is too narrow,” says Nawid Siassi. “Three points are crucial. First, cutting unemployment benefits does increase employment, but comes at a welfare cost. Second, distributional effects must be taken seriously: reforms affect people very differently depending on age, income and wealth. Third, general equilibrium effects are large. Capital, wages, job creation and interest rates all adjust simultaneously – fundamentally changing the impact of reforms. Micro-level studies capture only part of the overall picture.”

Original publications

Leo Kaas & Etienne Lalé & Nawid Siassi, 2023. "Job Ladder and Wealth Dynamics in General Equilibrium," CESifo Working Paper Series 10847, CESifo.
https://ideas.repec.org/p/ces/ceswps/_10847.html, opens an external URL in a new window

Rückfragehinweis:

Prof. Nawid Siassi
Institut für Stochastik und Wirtschaftsmathematik
Technische Universität Wien
+43 1 58801 10536
nawid.siassi@tuwien.ac.at

Aussender:
Dr. Florian Aigner
PR und Marketing
Technische Universität Wien
+43 664 60588 4127
florian.aigner@tuwien.ac.at