Excerpt
Inhaltsverzeichnis
1. Introduction
2. Unemployment and the transitional state: the example of Germany
2.1. Introduction
2.2. The German dilemma
2.3. Germany’s unemployment history and facts
2.3.1. The hysteresis effect as theoretical explanation
2.4. The Hartz reform and its long run effects
2.4.1. Improvements in the job assignment
2.4.2. The creation of new jobs
2.4.3. Social changes in the labour market
2.4.4. Structural changes
2.4.5. The downside of leisure
2.5. The heart of Hartz
2.6. Conclusion
3. Economic theory and unemployment
3.1. Introduction
3.2. Wage setting and the creation of unemployment
3.2.1. Efficiency wages
3.2.2. Labour unions
3.2.3. Minimum wage laws
3.3. Unemployment benefits and wage subsidies
3.4. Duration of unemployment
3.5. Dynamics: Natural Rate of Unemployment and NAIRU
3.6. Macroeconomic theories of unemployment
3.6.1. Keynesian theory
3.6.2. Monetarism
3.6.3. New-classical school
3.6.4. Neo-Keynesian theory
3.7. The types of unemployment
3.7.1. Cyclical unemployment
3.7.2. Seasonal unemployment
3.7.3. Frictional unemployment and job search
3.7.4. Structural unemployment
3.8. Solutions of behavioural economics and its use for unemployment
3.8.1. Behavioural theories and unemployment
3.9. Conclusion
4. The behavioural features in Identity
4.1. Introduction
4.2. Behavioural differences of unemployment and employment
4.3. Reference Dependent Mental Models
4.3.1. Path dependency, Social customs and steady states as lock-in
4.4. Attitude formation, expectancy value and attitude change
4.5. Control, Self-efficacy and self worth
4.5.1. Control theory
4.5.2. Self-efficacy theory
4.5.3. Self-worth theory
4.6. Mental health
4.7. Bounded rationality and loss aversion
4.8. Framing
4.9. Intertemporal choice and time discounting
4.9.1. Hyperbolic discounting
4.10. Conclusion
5. A moral hazard framework extended with a behavioural element
5.1. Introduction
5.2. Framework
5.3. Assumptions
5.4. Setup of the model
5.5. Context in the moral hazard framework
5.6. Decision Tree and optimisation
5.7. Calculations
5.8. Results
5.9. The essence and interpretation of the results
5.10. Perspective on the extension and modification of the model
6. 2/3 society: the better alternative to transitional states?
7. Conclusion
Bibliography
1. Introduction
Welfare states are in constant search for systems that are able to reduce unemployment without changing the established equity structure. Standard economic approaches argue with the focus on cost-benefit calculations that these systems can usually not work. Their economic explanations are however not fully satisfactory because they emit psychological influences. Adding behavioural elements to models and debates about unemployment systems increases the explanatory power. These elements could even support the use of some systems that seem unprofitable but might have a positive long-run effect on the rate of re-employment.
This thesis will apply elements and theories of behavioural economics to individuals who are in a system of unemployment-to-employment or in the forced transitional-work-to-employment system. Forced transitional labour systems are introduced to avoid the loss of skills and the negative psychological influences caused by unemployment, based on the assumption that scavengers are better than TV-watchers. These systems are however mostly valued for their immediate cost saving. The difference between the behavioural influences in the two mentioned labour systems on the individual will help us to value transitional states, the forced labour situation, higher due to positive long run effects for the job placement. These long run effects are not captured in classic short-run cost-benefit calculations of unemployment system. Behavioural theories help us to understand the positive and negative long-run psychological influences on the individual. The behavioural differences in the change from unemployment to employment and the change from the transitional state to employment allow us to form theoretical support for the proposition that individuals in a forced transitional state have less behavioural barriers to change to employment.
Standard search-theory argues that an increase in unemployment compensation increase the net cost of search to the unemployed. This creates an increase in the reservation wage for the unemployed and consequently increases the utility gained by leisure and the expected total effort of search (Albrecht & Axell, 1984). Welfare states or society will however not accept a strong decrease of unemployment compensation to lower the overall unemployment rate because of their equity norms. In the search of other incentives to search for jobs, transitional state programs have been introduced in many unemployment systems.
Problem statement:
Adding behavioural elements will help to better explain the effects of transitional state solutions. This thesis presents an argument why transitional state policy can help increase re-employment with the help of behavioural insights.
To illustrate the issue at stake we will discuss unemployment in Germany and the German concept of a transitional state that is included in the Hartz-concept in chapter two. In chapter three it will be discussed how history and different economic schools dealt with the concept of unemployment and how behavioural economics evolved. We will argue that economic discussions about unemployment and transitional work situations gain more understanding if we add behavioural dimensions to it. In the following chapter four we will introduce a selection of behavioural elements for a model that compares the modification of the behavioural change from one unemployment state into employment with the modification of higher after-unemployment wage. To justify and explain that the core variable of the model “identity” is different in the two systems, unemployment-to-employment and transitional-to-employment, the behavioural elements will be explained one by one and applied to the differences in the systems.
Chapter five first empirically explains the variables included in the model and the core variable “identity” which represents the behavioural elements introduced in chapter four. For this we use the theoretical framework of the moral-hazard problem in the principal-agent framework (Kunz & Pfaff, 2002), where society with its overall welfare presents the principal and the unemployed individual constitutes the agent. To analytically compare the two systems however, we will not discuss the psychological situation of the person in the state but the individual’s change from one state to full employment. The process of either leaving from unemployment to employment and the process of leaving the transitional state to full employment are therefore called “systems”. This behavioural difference in the two systems lets us include the positive effects that might not appear to be utility-improving for the individual himself but increases the re-employment rate. The analysis of the model yields the expected support that behavioural differences between the two systems, represented by the factor “identity”, have a similar effect in size on the search incentive of the unemployed as do higher post-unemployment wages.
This framework shows that the moral hazard problem that exists between the welfare of the state and the utility-maximising agent can in theory be improved by the new system with a transitional state.
2. Unemployment and the transitional state: the example of Germany
2.1. Introduction
The importance of intermediate or transitional states as a long-run solution to unemployment can be illustrated by the case of Germany. Germany serves as a good example because it developed one of the strongest welfare systems in the world which does not give much space to flexible labour market adjustments such as the cutting of benefits or a decrease of minimal wages. The German government has just realised a reform that implements a transitional state system.
This chapter will explain the problem of the rising German unemployment rate and the difficulties of creating search incentives. Next the creation of the German unemployment rates will be discussed and a comparison between German joblessness and its European neighbours is going to be drawn. Subchapter 2.4 will explain the goal of the Hartz-reform and briefly discuss the major system changes. It will concentrate on the motivational and psychological reasons given for the system modifications of the job assignment, new jobs as well as social and structural changes. The last part of the chapter focuses on the main effects, proposed and actual costs as well as the shortcomings of the Hartz-reform.
2.2. The German dilemma
Constantly rising unemployment rates have made the German government realise that the welfare system must not constitute a separate market next to the private market, competing between taking a job and staying unemployed. Being a country that is not introducing a minimal wage setting due to the politically strong unions, Germany is constantly troubled with ways to create enough other incentives for unemployed to actively search for jobs.
Over time, Germany has developed a strong welfare state that gives more emphasis to equity considerations than other countries. It is strongly rooted in the society of Germany that people who cannot provide their own living are strongly supported by the rest of the society. This caused a rise in welfare benefits that triggered the average minimum wage in the different industrial sectors to increase too. Since minimum wage jobs for under-qualified workers have to compete with high social welfare payments, artificially created unemployment is evident.
Social welfare payments increased in Germany from 1970 to 2000 with 450% whereas average minimum wage payments increased only by 350% (OECD, 2005). European minimum wage competition could have opened the margin for lower payments in Germany with the opening of the labour market in 1993, however the strong welfare state and union system blocked this process. The balance between social welfare and competitiveness on the labour market is a political question. Fact however is that the unemployment rate of under-qualified workers increased stronger in comparison to other qualification levels, which is due to increasing competition from other European countries in the labour market. The German unemployment rate of unqualified workers is the highest in the world, according to OECD statistics (OECD, 2005). It has been realized that the unemployment rate of under-qualified workers is a major cause of the high overall unemployment rate and has its origin in the social and welfare system. The choice between welfare benefits or a low wage is especially important to that group and therefore constitutes a major choice in the incentive system that the government creates. The lowest welfare benefit cannot be controlled because an overall minimal wage does not exist which forces the government to create alternative incentive systems.
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figure 1: Top Unemployment
The Hartz concept, which will be explained in more detail below, introduces a reform of the welfare system that reorganises the payment structure of unemployment benefits and more importantly rearrange the job placement and incentive structures. It reduces payments to voluntary unemployed, creates incentives for the ones who do not understand the positive effect of searching for work and helps the unemployed to remain on higher levels of effort, skills and work motivation.
Since equity questions are mainly political, it is not discussed here whether it helps to decrease or create minimum wage payments. In our discussion about the labour market we will focus on the mentioned reforms of the Hartz concept that introduced other incentives for unemployed to actively search for a job. With this focus we will try to analyse the difference between the old systems without the incentive system of forcing people to work with the system that is implemented with the Hartz reform in Germany that includes this incentive. To understand the need for the reform however, unemployment history will briefly discussed.
2.3. Germany’s unemployment history and facts
The oil crises in the early 1970s lead to a recession that increased unemployment from 1% to 3,5% in Germany. The second largest shock in the near past that increased unemployment in Germany’s still highly labour efficient economy was the struggle against the worldwide inflation in the beginning of the 1980s. The resulting unemployment was in some countries as the United States absorbed by an expansive fiscal policy but in Germany it lead to a constant increase of unemployment.
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figure 2: European Unemployment Rates
The creation of the European Monetary Union (EMU) from 1990 onwards and the connected demanded a strong budgetary discipline that caused higher unemployment in Germany, which had just recovered from a recession, due to the decrease of monetary flexibility. After a sharp fall between 1996 and 2000, the unemployment rate rose from 7,2% to 8% in 2005 in the EU-15 again (OECD, 2005). One of the countries that contributed significantly to this increase was Germany where the unemployment rate rose from 7,2% to 9,5% in the period of 2000 to 2005.
Since the recession in the 1980s Germany has been experiencing a constant base unemployment that might be have been further explained by institutional changes in Germany. Most of these changes have reinforced the strong basis of the German welfare system which further increased the inflexibility of the labour market. Other European Countries however started in the 1990s already to implement reforms of the labour market and have shown a constant decrease or stabilisation of the unemployment rate over the last years.
The example of the United States of America has shown that a decrease of unemployment can be achieved by means of higher flexibility in the labour market. Since 1975 all U.S. citizens have the possibility to receive a negative income tax. This negative income tax is paid if for example in the form of a negative 40% percentage of his wage when a married father of two kids earns less than 10510 dollar. The higher the wage, the lower become the percentages. Germany intended to implement a similar structure of negative income tax in 2002 with the “Mainzer Modell” which had however no success because it did not offer the support structure that the German society demanded for the unemployed and focused on impossible short term cost savings (Kaltenborn, 2005). European unemployment is therefore often attributed to the generous social insurance system and the demand for highly skilled and technological workers, which cannot be easily interchanged between industry sectors as it can be with low skilled workers.
The main difference between the U.S. and EU in the applicability of new labour market structures was in the more open acceptance of new structures in the society. The American market shifted the worldwide decrease in demand into wage rigidity which caused a larger gap between the skilled and the unskilled wage instead of an increasing unemployment. The European and especially the German governments had to allow the unemployment rate to rise.
The “Institut der deutschen Wirtschaft Köln” found in an analysis which directly compared the labour markets of Germany and the U.S. that the U.S. transformed wage gaps that were created in the growth process or booms into higher employment. The same growth led in Germany however mainly to higher real income for the already employed (Stettes, 2003).
Dividing the unemployment rates of Germany by age groups reveals that especially the unemployment rate of 18-24 year old worker rose in the last years (see table).
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figure 3: Unemployment by Age
This can be interpreted as a sign that structural unemployment, explained in chapter 3.7.4, is build up in which young workers are not supported correctly to reach employment. The increase in the unemployment rate of this age group plays an even more significant role for the analyses of reforms, when the psychological effects of the unemployment in early years are included. Youth unemployment causes psychosomatic and psychological symptoms, decreases social activities and increases the abuse of alcohol and narcotises (Hammarstrom, Janlert, & Theorell, 1988). Increasing youth unemployment in Germany created the highest demand for incentive reforms such as the ones included in the Hartz-concept.
Another interesting fact about German unemployment is its average duration that was a further cause for urgent reforms. The comparison of long term (12 month and over) and medium term (6 month and over) unemployment shows that there is an alarming increase of long term unemployment. This increase not only decreases the overall productivity of the economy but carries also psychological and sociological damages such as the loss of skills, the changing of social costumes, the loss of self confident and attitude changes (Hammarstrom, Janlert, & Theorell, 1988). This thesis will make use of the psychological differences between long and medium term unemployment to give stronger support to the system that forces unemployed to work and thereby overcomes these unfavourable behavioural effects.
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figure 4: (OECD, 2005)
The group of unemployed also plays a major role in the discussion of behavioural influences of long term unemployment. The discussion will exclude unemployed with tertiary education such as university or similar higher education. This simplification can be done when comparing the German unemployment rates between the groups (OECD, 2005):
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figure 5: Education and Unemployment
The largest group of unemployed workers in Germany is constituted by the individuals with less than upper secondary education. Since must be done because some behavioural reactions are different between the education levels, such as the danger to become addicted to alcohol.
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figure 6: Part Time Labour
The last explanation about the German labour market needs to be done to roughly understand the importance of the incentive solution discussed. Germany has a low rate of part time employment which creates low flexibility and low turnover rates on the labour market. These low turnover rates on the other hand create longer searching duration and for unemployed worker and a higher rate of lost skills over time which results in lower expectations to find a new job. The percentages of part time employment in Germany show a relatively low result, compared to other countries. One reason for the inflexible labour market are strict employment policies by the welfare state Germany and that do not encourage hiring and firing of short term labour.
A low level of part time labour, high youth unemployment and on average more long term than short term unemployment create a difficult situation for labour market reforms. German labour policies, covering not only unemployment benefits but also early retirement, sickness benefits and paid parental leave, are more socially orientated than in other countries. This complicates the implementation of rough incentive structures. We will not discuss the related subject of an optimal level of social protection that might only be given by more restrictive labour policies since it is too political (Feldstein, 1985). Therefore the result is not judged as a negative indication for policy making, but a negative indication for a flexible labour market reforms such as the loosening of labour contracts. For countries with restricted labour market flexibility such as Germany the transitional state solution grows in importance. The analysis will even argue that the behavioural influences of the transitional state system have the same effect like a higher flexibility on the labour market.
2.3.1. The hysteresis effect as theoretical explanation
A prominent theory to explain the stabilisation of a higher level of unemployment in Germany, even though other countries returned to their lower levels, is the theory of Hysteresis (Blanchard & Summers, 1987). It explains why temporary shocks in a system can cause permanent effects. Economic systems are often represented by a model of steady states that can be locally stable or instable and which are constantly influenced by external forces as well as their internal developments. The external forces usually move the dynamic steady state slowly in some direction. It can however also happen that an external factor has a powerful impact on the system, changing its entire balance. This situation is called in the field of mathematics the point of bifurcation, where a small change made to a parameter of a system causes a sudden quantitative change in the system’s long-term dynamical behaviour (Ludwig, Walker, & Holling, 1997). Hysteresis exists nevertheless only if the values of the parameters of the model have changed after the system has recovered from the parameter change and has found a new balance. An example for this would be the earlier mentioned inflation shock from which the USA has perfectly recovered its pre-shock unemployment rate, Germany stabilised however at a higher rate.
The hysteresis effect is often used as explanation for the institutional setting of strong labour unions and high labour bargaining in Germany. Collective bargaining hinders employers to reemploy and fire efficiently and thereby creates lower total employment than without collective bargaining. As explained before, the longer the unemployment duration is, the higher are the losses of skills and behavioural changes in the individual. A transitional state decreases these effects by remaining the unemployment in the labour force.
2.4. The Hartz reform and its long run effects
Great Britain has always been a role model for German labour market reforms. In 1999 they introduced the “Make work pay” system, in which families with an income of less than 13.230£would receive 545£ extra and 1.445£ per child. In 1998 they merged the old employment centres and social services department in a “New Deal” program, which is now the single access point for the unemployed and makes the job searching process more efficient, as they are registered, supported and sent to jobs at one single location. Furthermore and, for our purpose, most interestingly, is that all payments in Great Britain are tied to the condition that the person is actively searching for employment and takes every employment that is assigned to him of the “Jobcentres”. There are no payments to people who are able to work but are not willing to do so.
Instead of giving them an opportunity to choose by themselves which job fits their interests and skills, and thereby expose the job choice to their mental and motivational situation, as it was and partly still is done in Germany, the British “jobcentre plus” conducts interviews in their “Welfare to Work” program which tests the skills and abilities of the unemployed and assigns them jobs (Bryson, 2003). Decisions are based on the assumption that unemployed worker prefer staying under social welfare instead of receiving a low-paid job without welfare benefits, if no other incentives are given. This is due to behavioural choice restraining factors that increase the utility of the economically disadvantageous option.
Reality supports the assumptions that were taken about the low motivation of unemployed to find a job in Great Britain: when the incentives were increased in the described way and low skill work was supported with wage subsidies and other work encouragements, the unemployment in Great Britain fell to under 5% and strongly decreased youth unemployment (Millar, 2004). This supported that similar measures could help the German labour market.
Eventually in 2002 the German government decided that a similar reform was overdue and contracted Dr. Peter Hartz to head a commission for the “modern services on the job market” which became known as the Hartz commission. In August 2002 the commission published a report with proposals for structural reform, improvements in the process of job assignments, the creation of new jobs and social changes in the labour market.
The emphasis in our discussion will lie on the structural reforms. The other changes will also be discussed briefly to emphasis the overall importance of keeping the unemployed individual close to the work-situation or even in the work-environment to avoid the negative influences of idleness. The improvements in the job assignment as well as the creation of new jobs are prerequisites for the structural changes which creates the transitional state.
2.4.1. Improvements in the job assignment
The improvement in the job assignments are based on both players in the process, the unemployed and the state who leads the office. The importance of reasonability (Zumutbarkeit) has gained a much stronger emphasis in the Hartz concept than before, which, plainly talking means that the unemployed is expected to show more motivation and less avoidance.
The construct is based on the restructuring of the old system and totally based on the motivational behaviour of the unemployed. Before, the state offered jobs and the worker chose from the offer, whereas the new concept demands on the unemployed for showing more flexibility of acceptable employments over time. The reasonability reflects itself in payment, acceptance of work under qualification, part-time jobs and also flexibility of the job location, as can be seen in the graph below.
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figure 7: Support in terms of duration of unemployment
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JobCenters, that replaced the employment centres, are no longer offices where unemployed can search for a job but they are clients of the JobCenters that decide over their fate and impose penalties on non-cooperating individuals in form of decreased financial support. Even though some economists doubt that this reorganisation has a direct significant impact on the number of unemployed, it undoubtedly has a positive mental effect on the acceptance level of low-skill jobs and a positive effect on the working society that partly considers carrying a strong social system with a relatively high standard of living for the unemployed as a form of exploitation.
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figure 8: functioning of the quick-placement
The focus on the efficiency of job placement and the incentives to unemployed are however comprehendible: separated into the segments of short-term unemployed and long-term unemployed 35% of all workers that become unemployed find on average a job in the following 13 weeks whereas only 1/5th of the newly unemployed stay unemployed for longer than a year but account with this duration for 2/3 of the total unemployment rate (Möller & Sonntag, 2002). Thus, the emphasis on decreasing the amount of people entering long-term unemployment due to psychotically reasons appears logical.
On the side of the state the allocation process has strongly changed. Quick-placement describes a procedure that forces the unemployed to directly sign in at the JobCenters to avoid daily decreases of unemployment support, improvement of the information basis and to oblige the participating employers to conduct interviews fastly. Germany has historically a strong dismissal protection that gives the JobCenters sufficient time to avoid a high frictional unemployment. However this instrument will not help to decrease the high overall unemployment in Germany but will make the allocation more efficient and maybe less costly.
2.4.2. The creation of new jobs
The goal of the Hartz commission is not only to make the job assignment system more efficient but also to achieve the direct result of creating more jobs. The Hartz commission emphasises this objective without discussing different views on the evolution of the labour market, such as the 2/3 society that will be discussed in the last part of this paper. Structural changes have taken place in a total restructuring of the service office related to a reorganisation of the unemployment benefit system, a new “Job-Floating” structure and a partial transfer of some illegal employment into legal.
The restructuring of the service offices is conducted by the creation of a “PersonalServiceAgentur” (PSA) that is responsible for the fast and efficient placement of the unemployed, often based on temporary work. Assuming that the unemployed is accepting the assigned job and avoids the punishment connected to the earlier mentioned new reasonability rule, he receives an unemployment benefit. In the probation period of the PSA job he receives the full unemployment benefit. If the PSA decides that the job suites the worker, he is officially employed by the PSA which lends its workforce out to firms. This way, the unemployed gathers work experience and stays in the active labour force without experiencing the negative social impacts and has the chance to be absorbed into the labour force of the firm. These firms have the advantage over full employment solutions that they can use the PSA labour force for fast turnover rates and adjustments in times of demand fluctuations. Furthermore it gives the firms a chance to choose from a large group of integrated workers when selecting labour for full-employment. This sector employs mainly low-skilled workers and offers temporary work and was, until now, unsuccessful because of unfavourable contracting conditions in Germany, which put high emphasis on dismissal protection and minimum wages. The PSA creates therewith a new market sector of low-skill labour with a high labour transfer rate, flexible hiring conditions and low costs with subsidies of the PSA. One risk of this system is the possible misuse of firms that change to an extreme fire-hire concept, dismissing all long term contracts and create high costs for the PSA in terms of placement and interview expenditures.
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figure 9: PSA creates measurability and transparency
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The private alternative to the new Jobcenters are private institutions that bridge the gap between the job offer and the unemployed. Compared to the public solutions, they have a tougher set up and are usually specialised and thereby more efficient. Private job centres inform the public job centre about vacancies, which then sends the unemployed to the private institution.
All theses improvement have the potential to direct the labour market more in the direction of full employment and in the case of no substantial misuse by firms, decrease the costs of the social system by 30% . (Hartz, 2002) The problem that full employment might no longer be a feasible solution for the German market and the future economic situation allows more for a 2/3 society (see 6) is however not mentioned.
The new Job-floating structure expresses that payments are not made for a living of the unemployed but mainly to establish a floating of the unemployment from one job into another. Participating medium sized companies are entitled to make use of an interest free credit of 100000 EURO per employed worker under the lending conditions of the PersonalServiceAgentur. This has a significant impact on the investment possibilities of these firms that could create growth and thereby higher employment.
Another market failure that the Hartz report is trying to minimise is the illegal black market, which has an estimated volume of 300 billion EUR with five million full time jobs. Mostly privately employed part time workers are not registered to save costs, time and effort. The “Ich-AG” creates a possibility of legal work under 25.000 EUR on the basis of low bureaucracy and a very simple taxation system. The Hartz-report states in a comparison of the income in the black market with the old taxation system and the new taxation system that a gross income of 500EUR becomes net 220EUR in the old job system but becomes 450EUR in the transitional work taxation system. Even though this is still less than the 500EUR that is kept completely in the black market, registered work creates trust for the employer, security in the social life, and confidence in legal work. The registrations of employment of the this low income sector has, with this reform, increased from about 93.000 registrations in 2000 to 159.000 in 2003 and 183.000 in 2004. Furthermore 171.000 individuals made use of a business start-up subsidy of the state (Kayser, 2006). A problem will however still be to create enough incentives for creating an Ich-AG which is not only restricting the maximum amount of income but also includes some sort of taxation which is worse than no taxation at all. Furthermore 2/3 of all unregistered employed have more than one income source which is not accepted in the Ich-AG system. The creation of “Ich-AGs” experienced in 2005 a strong breakdown which was caused by the forth step of implementation of Hartz reforms. Which stopped the interest was the modification of the condition for the entitlement of the subsidy, which had before included recipients of the unemployment benefit but no longer did so.
2.4.3. Social changes in the labour market
The social changes in the labour market mainly affect the groups of the elderly and youth. The overall goal is to change the unemployment structure of elderly people in such a way that more of their work spaces become free for youth employment without harming the income structure of the elderly. A fixed compensation of income was created to motivate elderly people to accept jobs that pay less than their current income. The difference in incomes is covered for by the state. Furthermore the entrance into early retirement is subsidised for workers from the age of 55 onwards. This payment is created under new the BridgeSytem that separates groups out of the unemployment benefit. However this system creates high expenditures for the state that are not comparable to the gain of 10 to 20 percentage points of jobs that were formerly occupied by elderly people and are now held by the youth. Hence, the fixed compensation of income is a financial burden for the state but also carries the risk of creating fewer jobs than more.
New education and training time bonds, so called AusbildungsZeit-Wertpapiere, support the ease of youth inclusion in the labour force by creating easier access to jobs, interviews, internships, and practical work experiences. This bond can be exchanged into any work-experience that can be made in the labour market since the companies receive the subsidy of the bond. This way, education is brought more directly to the demand side of the labour market, the firms. Furthermore it creates the important incentive for companies to include more direct training and add more qualified workers that can be used by other industry sectors. This decreases the structural unemployment by approximating demanded skills of workers and supplied skills of freshmen.
2.4.4. Structural changes
Expenditure on unemployment services, including unemployment benefits, allowances and support of part-time or transitional work, amounted for 54.490 million EUR in the year 2004. As described above, most of Germany’s unemployment is structural. The structural problems in Germany range from the incentive and support structure of unemployed to the bureaucratic setup of the service offices. The focus of the Hartz-commission was therefore to achieve a cost saving by implementing structural changes.
The reform of the incentive and support system has at its heart a restructuring of the benefit system. Once a person has lost his job, he receives depending on his age and the period of time he worked for a period of between 6 and 12 month “Arbeitslosengeld”, an unemployment benefit. The amount of unemployment benefit paid depends on the average net wage received in the 52 weeks before entering the unemployed status and constitutes between 60 and 67 percent of the former wage. After this period of time, the unemployed person can apply for “Arbeitslosenhilfe”, unemployment support. This benefit is not restricted by a timeframe but the unemployed must however comply with demands set by the employment centre (Arbeitsamt).
A problem however is that these minimum payments cannot be lower than the local "Vergleichsniveau" (level of comparison) that is set by political equity reasoning and mostly fixed an monetary amount that is need in this area to live reasonably and additional services. A high level of comparison however strongly decreases the monetary incentive to find a poorly paid job. The German government thus counts on the implementation of a new reasonability rule (Zumutbarkeitsregeln) that is tied to the receipt of unemployment payments. These rules represent the earlier mentioned demands of the employment centre at the payment of unemployment support, which are mostly translated into forced transitional work and constant required searching effort for new jobs. If the demands are not being followed, social benefits are cut.
What had been two similar but independently functioning systems before, was merged to one system with one access point and one database about the benefit receivers. The new system is based on a three-step payment that can partly be followed in the graph below. If the worker becomes unemployed he is paid the unemployment benefit 1 (Arbeitslosengeld 1), which corresponds to the former system. The former social welfare (Sozialhilfe) and the unemployment support (Arbeitslosenhilfe) are now however merged, abolishing the responsibility problems between the two offices and creating less bureaucracy for the unemployed. The new unemployment benefit 2 constitutes therewith not only the collecting pond for the ones who will not find a job but also the situation that is supposed to create the incentive for the receiver of the unemployment 1 benefit to increase his effort and motivation and therewith avoid this payment. On the one hand, this reform increases efficiency and avoids double processing of the same information but on the other hand decreases the incentive to search for jobs for people who are fit to work but do not accept offered jobs because they know they receive the benefit for people who are unfit to work.
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figure 10: Payment Setup of the Hartz concept
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The most important reform in this setup is the timeframe of the unemployment status and benefit system. Stephen Nickell (Nickell, 1997) tested empirically whether the institutional situation in a country had a stronger influence on the unemployment rate or the duration of granted unemployment benefits. He came to the conclusion that the institutional effect is absolutely insignificant and that the duration of the granted support is the only influential factor on the rate (Südekum, 2000). The extrinsic incentive system is partly created on the basis of threatening lowered benefits and support structures. When the worker enters unemployment he receives the unemployment benefit 1 and is interviewed and tested by the PSA. If the unemployed is rejecting all work given because he feels that the work is under his ability and worth rejecting (Dunlop, 1957), such as the PSA work as well as the provision of work by the JobCenter, he can be punished with not only a reduction of his unemployment benefit 1 but also, when having slipped into the unemployment benefit 2 phase, an reduction of this benefit. If he decides however that his expectations on a job increase if he complies, not only because he gains experience and access to the labour market, but also because everyone else is complying and not complying is a signal of work unwillingness to any future employer, he enters the assigned PSA job. This job might be below his former ability level but inherits motivational and psychological effects as well as signalling effects.
In the case that the PSA contracting firm is not satisfied with the work of the unemployed and the PSA is not able to place the worker into another job, he can drop back into the unemployment benefit scheme and where he receives an amount, depending on the amount of time he has already been unemployed before the benefit system 1 or 2. What looks in the graph like a non escapable trap at the unemployment benefit 2 is in reality still open to all the unemployed wants to do. He is still in the database of the PSA and if willing to try other jobs or become more flexible in locations will also be assigned to PSA jobs from this situation.
Another important structural modification is the creation of JobCenters and KompetenzCenters instead of the old Arbeitsämter (employment centres) and Landesarbeitsämter. Internal change of the institutional framework is strongly emphasised in both reorganisations. Especially the creation of personal incentive structures for the formerly heavily bureaucratic working environment. It is a way to include the more efficient labour use of the free market into government structures. Furthermore a more efficient information processing is aimed at using better networks, centralised databases, and information processing tools.
The new JobCenters cover the services of the old Arbeitsamt of advising and supporting the job searching person but also includes the services of a social welfare office, youth welfare office and other social support, on the basis of the above described merger of the unemployment benefit 2 and the social welfare benefit. The created single access point for the unemployed does everything from profiling the unemployed over scheduling interviews to supporting the ones who have already given up searching for a job. The first access point at the JobCenter, the ClearingStelle (Clearing Point), forwards the individual either directly to a capacity advisor or, if the person needs support in the process, to a job advisor or forwards her or him to the next point, the Fallmanager (case manager) who will personally guide or exert pressure on him to come to a decision. The unemployed can also access a range of advisors from these points, covering social-, drug-, debts-, psychological- and residence advising. The unemployed has, with the consulting case manager’s help, the chance to obtain a PSA job or a full job, depending on the labour demand situation. The new JobCenters should therefore increase efficiency, decrease the waiting time of the job searching and cause thereby more confidence and less frustration. In addition, faster job placements decrease the cost for the state.
Landesarbeitsämter, now KompentenzCenter, act not only as the consulting body for the JobCenters about new ideas and regulations, but also act as the access point for bigger companies that plan to or are collaborating with the JobCenters. The latter are research institute and contact point for big businesses, political groups, and the news at the same time and thereby highly increase the transparency of the labour office. Moreover they play an important role in the contract negotiation with firms to make the PSA as flexible as possible. The analysis by the KompetenzCenters is represented in the figure below, starting with the analyses of the location including the infrastructure and settled workforce. The KompetenzCenter is in connection to the economic, research and institutional sector not only analysing but also the access point for networking, exchanging and negotiations.
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figure 11: Cluster creation of KompetenzCenters
2.4.5. The downside of leisure
The calculation of the Hartz commission is based on the assumption that excessive individual utility from leisure, such as the utility from voluntary unemployment, is unfavourable for the welfare of the entire state. We assume from here until the discussion about the 2/3 society in chapter 6 that idleness of labour is a non use of potentially productive resources and might even be unethical (Buchanan, 2001). Buchanan provides for this reasoning the example of a radiologist in early retirement. If retired, the value of the GDP falls by the total of $200,000 of forgone payments. The individual that makes the choice between productive work and idleness, be it because of early retirement or unemployment, therefore bears the full burden of payment. Anyone who earns less income and to take more leisure reduces the public benefit. Furthermore there will be less prospect of fully utilizing the advantages of division of labour as there are fewer inputs available.
The choice made by the unemployed does therefore exert spillover effects on others in the whole economic system which can be considered as to others which is the criterion for unethical or immoral behaviour. Buchanan however furthermore argues that the fact that an individual creates spillover effect on others by spending his resources on the higher valued leisure does not allow us to infer that he is immoral. To decrease the negative externality on the society however, the individual who forgoes income for leisure should pay not less taxes but more taxes, Buchanan argues, or should be animated to provide any other welfare providing service to the state. The Hartz commission seems to have adopted this reasoning with the creation of the PSA structure that uses the welfare to work principle. This principle therefore constitutes the heart of the Hartz-reform since it is the only change that has long run effects on the entire group of unemployed that are able to avoid the negative behavioural influences of idleness. In the next chapter we will however show that the focus on immediate cost savings that were expected from the job-placement of medium and long term unemployed is not sufficiently rewarding for the change. If the PSA reveals its potential to educate and train unemployed people, the overall workforce remains more competitive in the international labour market. With the growth of the service industry experience and education play a far subordinate role (Dockery & Elizabeth, 2001): The welfare loss from missing experience is therefore undervalued.
2.5. The heart of Hartz
The German labour market suffers from the difficulty to implement flexibility reforms because of the strong welfare state and the society’s emphasis on equity. This created a constant long term base of unemployed workers. The inflexible labour market policies together with a high rate of long term and youth unemployment made it difficult to create direct reforms that create short run cost savings in the unemployment. The Hartz-commission however implemented reforms that increased the efficiency and decreased the negative effect of medium and long term unemployment by creating the transitional work status under the PSA system.
To recall, the PSA decreases the overall search duration that creates a double negative effect by excluding labour resources from the market but also increasing the personal, mostly psychological effects that make the worker less attractive for future employers. The new reasonability indirectly influences the employment by decreasing the comfort-effect of the welfare effect and increase the personal effort for find new employment. Furthermore both Ich AG and Minijobs enhance the access to potential employment by supporting independent work, increasing the realisation of new ideas and decreasing the amount of illegal work. Another improvement should focus on the balance between young and old workers by the BridgeSystem that is also supposed to decrease the costs of the search effort and unemployment benefits for elderly people.
The official Hartz-report argues that the immediate changes could, as it can be seen in the graph, have a direct financial cost saving of 50%, created by a decrease of the number of unemployed by 2 million and a decrease of the average unemployment duration of 33 weeks. Recent studies about the actual cost of the system have shown that the Hartz-reform costs twice as much as expected (Schäfer, 2006). The German Federal Court of Auditors furthermore criticised the implementation that did not improve the situation for the medium and long term unemployed as planned but only for the short-term unemployed (Bundesrechnungshof, 2006). Nevertheless these short run calculation errors might be ignorable if the reported mistakes in the education of PSA job mediators is corrected (Bundesrechnungshof, 2006) and the medium and long run unemployed experience the advantages of being in a transitional state.
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figure 12: Predicted Financial Effect of the Hartz Reform
Critically one could however argue that the Hartz-report is still too weak in restructuring the current system, merely being an ideological framework than empirical paper that describes a future vision instead of current needs. Moreover the reform concentrates only on the goal of decreasing the unemployment rate without discussing alternatives such as the 2/3 society (see 6). Also less diverging alternatives such as the liberal idea of changing the ancillary wage cost system or the idea of loosening the European Deficit Criterion to enhance the use of government expenditures are not even mentioned in the Hartz-report. Slightly more emphasis could also been put on the fact that Germany is overall implementing its reforms too slowly in comparison to other countries that compete with Germany on the labour and social market, thereby loosing competitive advantages and investments. This effect is know as the “German disease” or metaphorically speaking “Reformstau” (reform traffic jam) and demands, speaking in technological terms, phased reforms as solution instead of Big Bang implementations as the Hartz-reform.
2.6. Conclusion
This chapter has shown that improving efficiency and keeping the skills of the workforce at a high level are an effective way to make the labour market in a welfare state more flexible. The flexibility of the German labour market struggles with the demanded generous social insurance system that prefers higher unemployment rates over wage rigidity. High youth and long run unemployment cause psychological symptoms and loss of self confidence which creates a constant base unemployment. This base unemployment is reinforced by the low rate of part time employment. To commit the unemployed individuals to the transitional state that supports the constancy of skills and decreases behavioural problems the reasonability rule was changed. This increases the motivation of search and acceptance of jobs below one’s own skill level. The increase in the agency’s efficiency decreases the amount of people entering long-term unemployment. Furthermore transitional jobs create a new market sector with higher labour transfer rates, flexible hiring conditions and lower expected costs while educating and training the unemployed. The significance of the duration of the granted unemployment benefit is therefore translated with the forced transitional work into higher signalling for re-employment. Moreover, re-employment is supported by the education and motivation of the unemployed.
Less frustration of searching and higher efficiency of placement were expected to decrease financial costs and average unemployment duration. However, until now the costs have been underestimated or wrongly calculated. This thesis will establish an argument that the behavioural influence of the system creates an extra benefit for the re-employment that has not yet been included in the direct cost calculation.
The following chapter will explain different views on unemployment which will lead us to the focus on the only satisfactory explanation of transitional states given by theories of behavioural economics.
3. Economic theory and unemployment
3.1. Introduction
Unemployment is considered to be a waste of resources and a market failure. Labour is a crucial factor of production, if less labour is used by the entire economy, lower levels of output are achieved and profits are decreased. If some labour power cannot contribute to the production cycle, the factor is a loss and creates direct and indirect costs. Macroeconomic theories always discuss the source of unemployment and ways to decrease its rate. Most of the macroeconomic schools, though, use assumptions that only partially correspond with reality. The behavioural economic approach, which includes self-perception and other behavioural features such as mental health in the reasoning of supply and demand of labour, can help to better explain and perhaps solve issues of unemployment.
Firstly in this chapter we will give a brief introduction to the creation of unemployment, the setting of wages and benefits, and the significance of the duration of unemployment. Secondly, the theoretical dynamics of unemployment will briefly be explained by means of the natural rate of unemployment and the NAIRU. This subchapter already gives strong support for the use of behavioural economics for incidents which are not explainable by other theories. Thirdly, the most accepted macroeconomic theories are examined and their shortfalls in the explanation of unemployment are emphasised. Afterwards unemployment will be separated into different types and it will be explained why behavioural economics is the only satisfactory theory to be applied to medium and long-term structural unemployment.
3.2. Wage setting and the creation of unemployment
Before explaining the influence of unemployment compensation in welfare states on the behaviour of unemployed individual it briefly needs to be explained how unemployment is created. The supply side of labour can lack of the skills or can cost too much for what they can offer which causes the demand side to pull its labour supply from another source such as another country. The action taken by the unemployed person depends then strongly on the strength of the welfare state he lives in. Individuals in poor countries often cannot afford being unemployed for a long period of time and accept jobs under their actual skill level, which is called underemployment by skills (Burris, 1983).
The choice between living of his own work or to live voluntarily of the unemployment compensation is however discussed in the next subchapter. In this subchapter we will focus on the creation of involuntary unemployment by the demand side of the labour market. Layoffs are usually caused by inflexible hiring and firing conditions of the labour market. If real wages are above the equilibrium level of wages, which is called wage rigidity, the job market does not clear which results in potential workers not finding a job. This additional cost of employing creates structural unemployment (see 3.7.4). There are three main reasons for wage rigidity: efficiency wages, labour unions, and minimum wage laws. All three causes will briefly be discussed since they already give support to the use of psychology and behavioural factors in the discussion of unemployment.
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figure 13: Labour Market Demand and Supply
3.2.1. Efficiency wages
Efficiency wage theory, the first cause of job rationing, is mainly based on the assumptions that higher wages increase the productivity of the employed. It not only reduces the turnover of workers, which is costly, increases workers effort, but also attracts higher quality applicants in the beginning which decreases the adverse selection problem between worker and employer as high quality workers are attracted. Furthermore shrinking of workers is minimized because it reveals the real quality of the work of the worker.
The most important effect of efficiency wages are on the moral and motivation of workers. Blinder and Choi find evidence that efficiency wages influence the morale considerations as well as mixed evidence for the influence of efficiency wages on work discipline (Blinder & Choi, 1990). Reciprocity, fairness and adherence to group norms are the most established psychological theories on which efficiency theory is based.
Reciprocity is an anthropological theory of gift exchange, that is translated into the exchange of commitment to the firm for a higher wage (Akerlof, 1982). Similar to this argue Shapiro and Stiglitz (Shapiro & Stiglitz, 1984) clarifying that higher pays decreases the market failure created by asymmetric information by reducing the workers incentive to shrink. In their model unemployment moreover serves as a credible threat for shrinking workers.
Fairness theory concentrates equally on the efficiency of the workers. It reflects the psychologically constructed fair wage that the worker expects from his job and incorporates psychological equity considerations. A worker that is, according to the theory, paid below his fair wage decreases his effort. The adherence to group norms is based on the reference group theory in sociology and the theory of group formation in psychology that describe the importance of group attitude formation that can create a productive environment.
The insider-outsider theory is another well-established reason for efficiency wages. Insiders can be the employed workers who are members of the corresponding union, outsiders are the workers that would prefer lower wages to have access to the market which is however prevented by unionised insider bargaining. The insiders thereby hinder the company to hire outsiders at a market clearing wage, that is lower than the wage that the insiders receive (Akerlof, 2001). This occurs by established internal group rules that determine not only the expected effort for the insider but also the fair wage that every worker has to expect. Moreover, employers cannot profitably hire more workers because the current insiders will not train the new workers and the employers reputation suffers (Akerlof, 1978).
Hence all theories have in common that efficiency wages have a positive effect on the working effort of insiders but create involuntary unemployment for workers with equal abilities.
Pfeiffer (Pfeiffer, 2001) shows in his paper „Ausmaß und Konsequenzen von Lohnrigiditäten“, that the German economy suffers from wage rigidity. By measuring the strength of wage rigidity with the amount of prohibited wage decreases in the absence of wage rigidity, which he calls wage sweep-up, he concludes that Germany’s wage sweep-up varies between four and eight percent. If the level of wage sweep-ups stays high over a longer period of time it results in lower sector employment growth rates and thereby to overall decrease of output. He furthermore emphasises that the insider-outsider mechanism has a strong influence on the wage determination in Germany, in which the pressure of the insiders increases the wage to protect them against a high worker turnover, further described below.
Efficiency wages reduce worker turnover, elicit worker effort, prevent worker collective action and attract higher quality employees, which are all favourable attributes for the company. On the other hand it leads to involuntary unemployment and wage differentials across industry sectors that can lead to an interest shift of workers with the same ability level to the concerned industry and create even more wait unemployment (L. Katz, 1986).
3.2.2. Labour unions
Another factor that is considered to increase structural unemployment and cause job rationing by wage alteration is the influence of labour unions. Unions exercise their monopoly position in the bargaining for wages and therewith increase the wage level above the equilibrium level. The conflict is the earlier mentioned insider-outsider conflict that is connected to efficiency wages. Unions for example create in collective labour agreements artificially high wages in the interest of the employees who profit from this protection. The unemployed part of the workforce would however like to decrease the entry barriers but cannot find employers that can hire them for the offered wage that is below the union wage. Data from 10 sectors has shown that workers represented by a union earn about 18% more than non-union workers in the same industry. (BLS.gov, 2005)
The table below represents an example of the American Union power where “U % of total” represents the number of union members as a percentage of the total number of employed workers. The “RBU % of total” column shows the number of non-union workers represented by a union as percentage of the total number of employed workers. The wage ratio is calculated in the following way: The mean weekly earning of union members (RBU) divided by the mean weekly earnings of non-union workers in the industry. The last row shows the result for workers in the different industries. The proportion of workers in unions and the wage ratio are strongly correlated.
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figure 14: Union membership and wage ratios by industry (Mankiw, 2002)
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This correlation of union membership and high unemployment rate in industries such as the transportation sector proves the negative effect of strong unions on the unemployment rate.
Gangl provides the evidence for this assumption for since the early 1980s in both the United States and Germany. (Gangl, 2002). However, from the 1950s to about 1980, the rate rose without an increase in the power of the unions. This however does not refute the theory since other factors influencing the natural rate of unemployment were not constant in that period.
3.2.3. Minimum wage laws
Minimum wages set a payment floor in a country. They stabilize social fairness and reduce the exploitation of low-skill labour as well as theoretically encourage low skilled workers to stay in education and therewith develop a higher average level of education that leads to economic development. On the other hand minimum wages are often used as an instrument for politicians and unions to gain public power, decrease the economic competitiveness of firms, and cause higher base level unemployment and higher layoff rates. If the minimum wage exceeds the equilibrium wage for unskilled labour, artificial unemployment is created. An increase in the minimum wage in a sector in which this wage already tops the equilibrium clearing level, increases involuntary unemployment in the specific industry. Studies of Card and Krueger (Card & Krueger, 1994) about the minimal wage increase from $4.25 to $4.75 in the US in 1996 have shown that it increased the unemployment among teenagers but not in any other demographic groups. An increase of 10% of the minimum wage increases teenage unemployment by 1 to 3%. Furthermore Phelps and Zoega (Phelps & Zoega, 1998) have shown that the trend in the real minimum wage is similar to the behaviour of the natural rate of unemployment. For this reason economists have generally never been in strong support of minimum wage laws, even though supporters such as Card and Krueger (Card & Krueger, 1994) have shown that a minimum wage only affects the payment structure and has no influence on the unemployment rate. The influence of a minimal wage on employment is therefore not unambiguous and still subject to discussion.
3.3. Unemployment benefits and wage subsidies
Unemployment compensations are paid by the society to decrease the problematic situation of unemployed individuals. They usually cover benefits, medical costs, health insurance, and a standard set of commodity goods to decrease the negative psychological impact on the life. However, the higher the unemployment compensation is, the lower appears the opportunity cost for the unemployed to remain unemployed and the less monetary incentive exist for taking a low-paying job (Snower, 1994). This increases the search time and decreases the acceptance level for jobs of the unemployed. Furthermore it cuts the range of options that are left for employers in terms of payment and worker turnover rates.
Unemployment insurances can take the form of unemployment benefits, health insurance, welfare, direct unemployment compensation and training subsidies. Theoretically, these unemployment insurances increase the search unemployment because they reduce the opportunity cost of being unemployed and the urgency of finding work. Studies have shown that the duration of the average time of unemployment is correlated with the eligibility for unemployment insurances (Mankiw, 2002).
Gangl however showed in his paper “unemployment benefits as a search subsidy: new evidence on duration and wage effects of unemployment insurance” (Gangl, 2002) that the effects of unemployment benefits on job search are less negative than expected before. However, raising the reservation wage or support of the unemployed has the same effect of decreasing spell duration and improves the quality of the work done. He therefore argues that the compensation has no negative effect and is supported by the post-unemployment wage that increased work quality strongly in the 1980s and 1990s in both Germany and the United States. He furthermore argues that small delays in unemployment duration can have a great effect on the match quality of worker and future job.
In the overall discussion about long and medium term unemployment these small delays are neglectable. Welfare states such as Germany experience the incentive gap between the unemployment compensation and a low paying job more than other countries in which labour efficiency is valued more than equity considerations. Since a wide range of unemployment compensations incorporates a high level of utility from leisure for the individual, transitional state programs are essential to preserve the working mentality of unemployed individuals.
3.4. Duration of unemployment
The duration of unemployment mainly depends on the cause of the unemployment. Short term unemployment is often caused by frictional unemployment, where the allocation process causes the duration. Long term unemployment however is mostly caused by structural problems. Most of the long term unemployed have had work experience but lost their job due to reorganisations.
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figure 15: Bureau of Labor Statistics on unemployment duration (BLS.gov, 2005)
In the table above the second row shows the percentage of all unemployed whose duration of unemployment lasted for the indicated time. The third row represents the total time spent unemployed assigned to workers in that category. This means, the ratio between the total number of weeks spend unemployed, which is computed by multiplying the total number of unemployed by the number of weeks of average unemployment, and the number of people in that category or duration multiplied by the average duration of unemployment for a person in that category.
The result of these statistics show clearly that most of the total time spent unemployed is attributed to people who are long-term unemployed, which is 15 weeks or longer. Even though this result represents U.S. data, it is similar in all western countries. Most unemployment time, and thereby also cost, is attributed to the long term unemployed.
The main problem concerning long-term unemployment is the depreciation of human skills, motivation and work effort, sometimes called human capital, which occurs in this time (James, 2000). Qualification and skills decrease constantly with time when a worker remains unemployed and thereby decreases his value on the labour market.
3.5. Dynamics: Natural Rate of Unemployment and NAIRU
The natural rate of unemployment, a term established by Milton Friedman, assumes that the labour market clears in the long term in one wage and employment level where demand and supply for labour stabilise. We will use this theory and the theory of the NAIRU to explain that the only acceptable solutions to malfunctioning of these systems come from the area of behavioural economics.
The chain of reactions of the natural rate of unemployment starts with workers that have a misconception of their wage settings. They demand the expected nominal wage instead of an increased real wage, a type of money illusion, which causes them over time to increase the labour supply. The firm’s reaction would be in this setting to increase the cheaper labour supply and thereby increase its output and decrease unemployment which would lead to a state of total employment with a natural rate of unemployment that would only represent the voluntarily unemployed. If the cyclical rate would be known, the natural rate would be the remainder of total unemployment.
However the OECD or the German Arbeitsamt can not distinguish between the natural rate and cyclical fluctuations. Unemployed for the statistics are workers, who are looking for employment and are able and willing to work at the current wages. A counted unemployed is therefore only every individual, who is involuntary jobless. Voluntarily unemployed workers do not accept to work for personal purposes or possible earnings such as people that live of inheritances or housewives that prefer to stay home.
In this setting of the Natural Rate of Unemployment the interplay between unemployment and inflation as annual nominal wage growth of employees can be plotted on the Phillips curve, which shows in the Keynesian theory the connection of low unemployment and high inflation rates as well as high unemployment and low inflation, as already mentioned earlier (Fonseca, 2001). In the figure below, one can observe that this inverse relationship is relative, plotting the natural rate of unemployment against the fluctuations of inflation from the expected rate of inflation.
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figure 16: Keynesian Phillips curve
The natural rate of unemployment is the rate at which the inflation is equal to the expected inflation. Likewise is the expected inflation the rate that satisfies that unemployment is equal to its natural rate. When demand is high and unemployment low, workers can bargain for higher nominal wage increases than when demand is low and unemployment high (Akerlof, 2001). Governments could therefore choose their political emphasis as from a menu: More conservative governments would choose a rate with lower inflation and higher unemployment, social governments a lower unemployment rate and higher inflation. High inflation rates cause a relatively low decrease in unemployment. On the basis of the theory of the Keynesian Phillips curve it is therefore impossible for governments to intent a decrease of unemployment and hold the price stabile. Governments need to find a trade off between unemployment and inflation.
In the simple model on the natural rate of unemployment in the short term the number of workers in the labour force is denoted with L, which is exogenously fixed, the number of employed workers with E, the number of unemployed with U and the unemployment rate with U/L. During any given month, s represents the fraction of employed workers that become separated from their jobs, called the rate of job separations, and f represents the fraction of unemployed workers that find a job, the rate of job finding. These factors are both exogenous. The model assumes thus that the transition between employment and unemployment can be represented by a circular flow:
E ➔ s x E (# of employed people who lose their jobs) ➔ U ➔ f x U (# of unemployed who find jobs) ➔ E ➔…
The labour market is considered to be in a steady state if the unemployment rate is constant and thereby fulfils the condition:
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The equilibrium unemployment rate after conversions is:
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This would mean for a month in which 1.5% of employed lose their jobs and 20% of unemployed workers find jobs, that the rate of unemployment is
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or 9,8%. Any decreases in the long term unemployment rate are therefore only possible by either lowering s or increasing f. Mankiw (Mankiw, 2002) gives two main reasons for the possibility of f being larger than 1, which represents immediate finding of a job. One is job search and the other the earlier explained wage rigidity.
Monetarist theory of Milton Friedman added to the simple Phillips curve model that long term unemployment was not to be decreased with higher inflation rates. Even though there exist short term real effects by the trade-off between inflation and unemployment, Monetarists emphasize that constant adoptions to the changing inflation to the unemployment rate cause the economic agents to change their expectation and loose trust in the stability of the monetary market (Friedman, 1968). Furthermore their interest in real instead of nominal changes, create a constant inflation with one unique natural unemployment rate that results in a vertical Phillips curve instead of an unemployment-inflation trade-off (Akerlof, 2001). Only constant expectations of the value of money create stable growth and a firm economy.
In contrast to the Phillips curve and its natural rate of unemployment, the Non-Accelerating Inflation Rate of Unemployment (NAIRU) represents an unemployment rate that is modified for the inflation threshold (Friedman, 1968). If real unemployment is below the NAIRU the inflation is not only increasing such as stated in the Phillips curve, but it is more specifically increasing at an accelerated speed. The NAIRU is caused by the fact that both labour and product markets are imperfect. The labour market especially suffers under the pressure of unions and politics. Collective bargaining of the employees can lead to an artificially high real wage. The more workers are employed by the firm the higher is the bargaining power of the workers, which leads to a reverse effect that increases unemployment. The firm can also alter the market clearing wage with a price-determined real wage that increases the firm’s profit. The rate at which the union demands real wage, influenced by their inflation expectation, is equal to the price-determined rate of firms, which determines the NAIRU.
If the government, as stated in the graph below, tries to decrease the unemployment rate with an expansive monetary policy, the short term Phillips curve moves from A to B. The adaptive expectations of the economic agents diminish this effect however in a later period with a higher expected inflation rate that results in an increase in nominal wage demands. Firms on the other hand pass the increase input costs of labour on to prices until inflation exceeds the initially anticipated rate of the worker (Akerlof, 2001). This shifts the Philips curve higher and the economy to point C and over time back to the NAIRU unemployment rate. The unemployment rate stays therefore on the NAIRU and inflation rises, if the government tries to stimulate the economy with expansions in the monetary market. Over time only the inflation expectations increase if the rate of unemployment is held under its natural rate. However The NAIRU can not be calculated and the focus can therefore only lie on stabilising the inflation rate.
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figure 17: NAIRU
The main difference in terms of unemployment between the classical Keynesian model of unemployment and the NAIRU is that the latter allows the labour market to constantly experience an involuntary unemployment whereas in the theory of the classical Natural Rate of Unemployment (NRU) the labour market clears in the long run and all unemployment must be voluntary.
Economists often choose a middle course with a short run Phillips curve that explains the short run dependency of inflation and unemployment and a long run NAIRU. Akerlof on the other hand suggests that the natural rate hypothesis breaks down at high levels of unemployment and low inflation rates (Akerlof, 2001). He bases this on the empirical fact that unemployment in the U.S. was in the 1930s much too high for any natural rate. According to the theory, price deflation should have accelerated but did not. Apart from the first years there was no deflation during the time but a high rate of unemployment. Furthermore Staiger, Stock and Watson (Staiger, Stock, & Watson, 1997) compute a 95% confidence interval for the U.S. natural rate which exceeds 5 percentage points which is more than three times the standard deviation of the US monthly unemployment rate over the last 50 years (Akerlof, 2001).
This lead to developments of behavioural hypotheses for the stable trade-off between unemployment and inflation at sufficiently high unemployment and low inflation rates. The first hypothesis is that workers resist cuts in nominal pay and firms rarely impose them (Akerlof, Dickens, & Perry, 2000). This is consistent with the psychological prospect theory that argues that individuals elevate changes in their circumstance according to the gains or losses. If losses are relatively small they are not considered, larger losses are however weighted stronger than larger gains. Fortin examined at an inflation rate of 1,2 and an unemployment rate of 11 percent in Canada that only 5,7 percent of union agreements included wage cuts, whereas 47 percent arranged wage freezes (Fortin, 1996). Workers that take today’s wage as reference and managers that cut wages only as a last resort create therefore downward wage rigidity.
The second hypothesis argues that a number of workers does not consider inflation as being significant for their decision making in wage bargaining at very low inflation rates. However, when inflation rises, the influence of inflation plays a greater roll and workers include it in their wage bargaining. Cognitive psychology suggests that people are more likely to ignore variables that are unimportant to their decisions (Akerlof, 2001).
This demonstration further explained the inclusion of behavioural economics not only in the field of market failures but also as an explanation of the malfunctioning of classical economic models.
3.6. Macroeconomic theories of unemployment
Over time a wide range of economic theories have develop different approaches to solve the question of unemployment. All except behavioural theory have been relatively unsuccessful to explain medium or long term unemployment. Nevertheless the theories and their weaknesses must be explained to give a strong foundation to the inclusion of behavioural elements in economic models.
3.6.1. Keynesian theory
The predominant opinion in the 1960s about unemployment was based on the Keynesian theory, stating that the demand of labour, such as other factor inputs used in the economy, is a dependent variable on the demand for good and services in the economy. This simple interconnectedness is represented in the Phillips curve, an inverse relationship of the unemployment and inflation rate, described under 3.5.
This relationship became the tool for European and North American unemployment policy setting in the 1960s and was used as an apparatus to control the economy. The governments’ role in this methodology was to decide about whether more inflation or more unemployment was needed by coordinating the fiscal money side. The essence was to achieve the balance of stable inflation and full employment with strong fiscal policy controls.
Keynes focus on the value stability of currency was however not able to explain the 1970 demand and supply shock caused by the oil crises. The increase in oil prices, which also strongly influenced other prices, rapidly increased the growth of inflation. This inflation was not caused by overall demand being higher than overall supply, as predicted by the Phillips curve, and therefore did not decrease unemployment. The decline in overall production together with increasing overall costs by inflation started a stagflation. The existence and influence of demand and supply shocks does nevertheless not refute the negative relationship on the Phillips curve. Gordon (Gordon, 1997) emphasises for that reason that demand shocks cannot be considered in the analysis of labour demand questions on the Phillips curve because demand factors are not included in the model.
3.6.2. Monetarism
Out of the developments of economic theory in late 1960s emerged the more liberal Monetarism of Milton Friedman. In this theory economic activity is regulated by the supply and demand for money, controlled by the central bank that focuses on the price stability, and inflation is only an effect if the supply of money is larger than its demand. The main difference to the Keynesian theory is not in the demand driven model of money but that Keynes focused on the value stability of currency whereas Milton Friedman put the emphasis on price stability: If money supply were expanded, people would increase spending which would lead to higher aggregate demand. This reasoning concluded with the assumption that money supply did not matter. The influence of expectations were for Friedman the essential critic on the Keynesian market model (Friedman, 1968). The effort to exchange higher inflation for a lower unemployment is attended by the change of expectation of the economic actors that adapt their inflation expectations and therefore change, for example, their demanded real wage in wage bargaining. Since the actions of the Central Bank were the source of inflation and price stability, excessive monetary growth was for Monetarist best controlled by restraining government spending.
In the late 1970s governments’ spending in the U.K. and U.S. was high to control the monetary growth but lead only to little economic growth, extremely high unemployment and a central bank that still raised the interest rate to restrain credits. Only the liberalisation of the credit system that came with the anti-monetarist movement improved the situation.
3.6.3. New-classical school
The school that developed in this time was called new-classical economics with its leading figure Robert Lucas. The school established a new base-concept of the view on economics. The economy for them was entirely based on the actions of individual agents that form the economy with their actions and behaviour. One of the major assumptions of new-classical economics is that agents are utility maximising and have rational expectations. Furthermore exist in this school a market clearing price and wage at which the economy is in equilibrium and experiences full employment (Lucas, 1972). The view created models that were hard to compare with for example Keynesian models and were based on the intertemporal utility maximising behaviour of representative agents in the economy (Lucas, 1983). Rational expectations were an aid to create valuable and stable models but Lucas stated himself that this assumption made it hard to translate them to reality (Lucas, 1980). One of the major developments of the new-classical school was the Ricardian Equivalence, of Robert Barro, which states that every deficit spending today is a tax increase for tomorrow and that every fiscal policy based on the national debt spending leads to the change of the expected tax level of the citizens. Another more contradictory development was the Real Business Cycle Theory, which stated that any monetary alterations had no influence in cyclical fluctuations because ever economic agent enjoys perfect information and can therefore rationally adopt its expectations to the changes (Barro, 1974). Therefore technological change was the only reason for cyclical fluctuations in this school.
3.6.4. Neo-Keynesian theory
The level of abstraction of the new-classical theory based on strong assumptions such as perfect information and rational decision making gave however rise to the politically more applicable theory of neo-Keynesians. In his Nobel Prize lecture the economist Akerlof (Akerlof, 2001) draws attention to six macroeconomic failures that are not accounted for in the very reduced behavioural model of the school. First the new classical model allows any worker without job to obtain a job by offering to work for less than the market clearing wage which does not allow the existence of involuntary unemployment. Furthermore Akerlof mentions the failure of deflation to accelerate when unemployment is high, the prevalence of undersaving for retirement in which people tend to underestimate their future needs and the persistence of a self-destructive underclass which is not related to low endowments of human capital.
The Neo-Keynesian school argued that the demand for money is intrinsic to supply and hard to predict. In Criticism of Monetarism the theory argues that the velocity of money is not constant and the relationship between inflation and money supply growth weak. The school furthermore states that the flexibility of prices is reduced because agents cannot always act rational and cannot quickly change his or her expectations, because he suffers from imperfect information, sticky prices and menu cost (Gordon, 1990). Information and the actual behaviour of agents play a significant role in the Neo-Keynesian theory as well as real effects of short term effects of monetary policy.
The essence for today’s usable economic policy is that both fiscal as well as monetary changes have a short term effect on the economy. Government spending or tax decreases increase the demand in the short term, a systematic growth of the economy can however not be created. Just as little can inflation decrease unemployment which is strongly influenced by soft factors of all actors, such as skills, the duration of unemployment, social norms, motivation and expectations of future jobs.
3.7. The types of unemployment
The creation of unemployment is a steady process. Cyclical and technological changes, seasonal layoffs as well as structural processes create a constant flow of workers into unemployment. Unemployment would not present a problem if the outflow of unemployment would be equally stable to the inflow into unemployment and not as dependent on structural political decisions. Unemployment can be explained by four concepts that explain the inability of workers to reach employment. All four concepts, cyclical, seasonal, frictional and structural unemployment are interrelated but emphasis distinct causes or effects of unemployment. After having clarified the emphasis of each of these concepts we are going to focus on reforms that decrease unemployment with the help of a transitional state.
3.7.1. Cyclical unemployment
Cyclical unemployment is caused by cyclical business changes that decrease demand which falls short of the potential output. Cyclical demand fluctuations can be caused by increasingly high imports in comparison to exports, underconsumption, low government spending or high taxes that generate decreasing public spending and other factors such as negative investment expectations. These factors cause a change in price levels and sales and require alterations or reallocations of the inputs such as labour (Lilien, 1982).
Recessions are often caused by changes in demand in a sector and as a result often also reduce the production factors of that sector. Not all of these fluctuations can be captured by layoffs since labour is strongly protected. Hence, prices of the goods need to be increased to compensate for the stickiness of the factor labour. If only price increases occur, without decreases of prices in other sectors, the overall price level increases which causes an increase in the inflation rate. Higher inflation rates can however be more unfavourable to the middle class than lower wages, since better-off individuals can choose investments such as to avoid inflationary losses.
Technological change also influences cyclical unemployment as automation makes the production of some goods more labour redundant which in turn can cause higher unemployment in the sector. However, technological advance is also essential for competitiveness and growth, which can create new jobs.
Keynesian economists that see the aggregate demand as the motivating factor in an economy instead of the expected output, argue that macroeconomic instruments, such as deficit spending and expansionary monetary policy, can be used to decrease unemployment (Bennion, 1943). Contrary to the classical supply-side driven economists that aim for full usage of all resources, the neoclassical theory with Keynesian basis allows the economy to reach general equilibrium with varying resource utilizations. This means in the context that full employment does not have to be reached and cyclical unemployment has a variable natural rate of unemployment.
Employment agencies and job centres cannot take influence in cyclical changes. Only the employment policies of the governments and the central bank have this possibility. The government can shift tax payments, giving tax relives or increasing the government spending, whereas the central bank can decrease the interest rate to induce an increase in investment. This in turn can increase demand and stimulate growth and employment.
3.7.2. Seasonal unemployment
Seasonal changes have a strong influence on the demand and supply of labour in some sectors. In the winter some building sites have to lie idle, not only because workers have to work outside but also because materials do not allow being utilised in some weather conditions and other raw-materials are simply scarce (Bonin & Davis, 1972). Another sector that is strongly affected by seasonal changes is the tourist industry. Demand for labour in holiday villages is totally dependent on climate conditions. Seasonal workers are unemployed at regular intervals. Companies that only increase the labour input in one season have permanent labour and seasonal labour. The former is sometimes paid higher since they are often paid on piece-work.
In the idle seasons seasonal workers are often unemployed and live from social welfare. The risk that seasonal workers become long-term unemployed is even higher, when regular seasonal work stops. Tools to decrease the unemployment rate that is caused by seasonal unemployment are rare. Diversification of the labour skills, that different work can be done in different seasons, as well as push production that constantly supplies a product, even though it is sold in peak times, can decrease seasonal work and increase permanent labour. However the move from just in time production to efficient storage production occurs less frequently than the opposite way.
The opinions on the influence of seasonal work diverge. On the one hand, it can be argued that seasonal employment is filled by long-term unemployed and thereby increases the possibility of reintegration of unemployed into the labour force. On the other hand, it is equally easy to argue that the redistribution of work over the seasons might have a negative influence on the competitiveness of a firm, even though it lowers costs. The overall effect of changes of seasonal employment structure is ambivalent and depends on the specific sector concerned.
3.7.3. Frictional unemployment and job search
Frictional unemployment is caused by inefficiencies in the allocation process of unemployed workers to jobs. Not only the search effort, but also the application and relocation consume time that is accounted for in unemployment. Frictional unemployment occurs even when there are free jobs and wages are flexible and also exists at full employment. This frictional gap is created by factors such as asymmetric information, immobility, requirements and abilities. Asymmetric information emerges from the fact that information about neither vacancies nor job candidates is easily accessible. The limited geographic mobility of workers causes that empty job spots are not filled with the optimal worker (Simon, 1988). Furthermore, the progress to more specialised work causes the worker to be unable to fulfil the requirements for a job due to lacking abilities. Even though quantitative labour demand might cover supply, the qualitative requirements of the demand deviate from the fulfilled requirements of the job searcher.
Sectoral shifts, which are changes in the composition of demand among industries or regions, also contribute to frictional unemployment, since it needs time for workers to change the sector. The rates caused by this can be severe: The U.S. textile industry has been declining for years and many workers were unlikely to have the skills necessary for another job in a booming industry. These workers had been working in the textile industry for decades and were therefore less likely to invest in the acquisition of skills for another industry sector and became discouraged to work. These structural shifts are however due to continuous changes in innovation and demand.
Sectoral unemployment is a source of frictional unemployment but can hardly be measured, because no index measure exists. Oil prices are considered a source for sectoral shocks since a fluctuation in oil prices causes a change in the demand for workers the oil industry. Another form of frictional unemployment is so called wait unemployment. Jobs in some sectors are more popular and to many people it is worth to wait for vacancies in the desired job area. Another reason for the existence of wait unemployment are payments of efficiency wages which might increase the productiveness of the people who receive them but constitute a limit for the amount of people that can be hired by the firm. Again the monopoly force of unions that creates artificially high payments in collective labour agreements, efficiency wages, and minimum wage laws have a strong influence on this type of unemployment.
Altogether it is beneficial to decrease the search time, not only because long search time can lead to a decrease in search effort, but also because faster allocation leads to higher productivity of the economy. To decrease frictional unemployment, employment agencies and job centres can speed up the processing of information between the unemployed and the companies. Furthermore, applicants can be supported and the mobility deficit decreased by supporting relocations and transportation. Governments provide employment agencies to decrease the information asymmetry between job openings and available workers and grant access to job training programs in which workers that need to change the sector acquire the skills needed for another sector. Furthermore tax restructuring and deregulation help to increase the turnover of workers. A measure for the optimal amount of search time and frictional unemployment does not exist. Allocation time is essential to find the right worker with the right skills for a job, however overly long allocation is not good either. By no means should accelerations of the allocation process undermine the quality of allocation.
Summarising it can be said that frictional unemployment is created by the divergence of demands by the employer and supplied levels of education, skills and wage requests by the worker. Social systems generally increase the amount of frictional unemployment by decreasing the motivation of the unemployed to find a job and to accept a low paying or, in their point of view, degrading work (Mankiw, 2002). Social systems offer a high standard of living, security and no fear of a sudden loss of income. To remove some frictions in the market, reforms especially attempt to improve the job search process, make the placement processes more efficient, and increase the information intake. Furthermore a weakening of the union power, especially in terms of collective wage bargaining, was visible in recent years. Total labour expenses can not only be decreased by decreasing the union bargaining position but also by decreasing the ancillary wage costs with deregulations. As mentioned before, the focus of this thesis will remain on the improvement of the job search process by remaining the individuals in the labour force.
3.7.4. Structural unemployment
Structural unemployment is the general mismatch of demand and supply of workers. Unemployed workers have the wrong qualifications for a job or the job demands specific skills that the available worker does not have. Another frequent cause for structural unemployment is the inflexibility of the movement of labour, occurring when the desired job exists but the location is not acceptable for the worker. The willingness to change the sector oneself into another area is also considerable small and a cause of structural unemployment if the demand changes. However the rate of job hiring can also be a cause for structural unemployment (Jackman & Roper, 1987). It is therefore more a collective term for regional, youth, technological and other unemployment with structural causes.
Technological change usually shifts workers from one sector into another. Machines replace simple human work but need control. Furthermore the service sector grows with a constant increase of technology use. This modification demands further education with which some workers, especially in the low-skill sector, cannot cope with. The need for new qualification creates structural unemployment.
Youth unemployment is often mainly caused by search unemployment. The high search time is however caused by their lacking plans for the future. If it is not clear what job is desirable, lower effort is devoted to find employment. This unemployment becomes frictional when the market does not allow a person to be employed in the sector he chooses. The main reason remains that the demanded level of qualification for a job does not correspond with the supply of skills of the unemployed. Because this often concerns entire branches, structural unemployment is often called sectoral unemployment. This simple structural unemployment can be decreased by support of further education, retraining and increase in skills. This would support the placement of unemployed.
Another form of structural unemployment is systematic unemployment. It originates in weaknesses of the economic and social structure of a country. The country might be unable to create enough work, because the location and settings are not interesting enough. This strongly applies to Germany where the business environment is said to be unfavourable and companies are reluctant to invest in some sectors.
The general focus lies on improvements of the conditions of companies. A decrease of their burden through i.e. tax relieves and a transition to more flexible constraints, make an economic area more interesting. However, this redistribution for the benefit of the companies is in the short run only in favour for the entrepreneurs. Employees and the job market only benefit in the long run, when the higher profits of the firms lead to higher employment and higher wages.
In contrast to the definitions of frictional unemployment, which are partly based on the same factors such as inefficiencies in the job allocation, structural problems are harder to solve and the process consumes much more time. Cyclical unemployment on the other hand can cause in the long run structural unemployment if the cyclical change lasts that long that workers loose their skills and motivation to search for a job. Long waiting time strongly decreases mental stability and often decreases overall self-consciousness about its own abilities, as well as increases the possibility to change its social status with reduced income and different personal problems (Hamilton, Merrigan, & Dufresne, 1997). The last mentioned scenario could, if targeted, help to decrease structural unemployment by creating high demand and higher output. However as Okun`s rule of thumb says, one percentage of unemployment above the natural rate would demand a two to four percentage increase of the growth of output (GDP) (Okun, 1974): Abbildung in dieser Leseprobe nicht enthalten. If the actual growth of the economy is not present, behavioural problems can only be avoided by creating a transitional state that decreases these unfavourable characteristics of unemployment. The greatest challenge in structural unemployment remains the divergence between the speed of a changing economy, the speed of changing mental models and education of people for a constantly adopting society. A transitional state therefore aids to decrease structural unemployment by remaining the workforce competitive and especially flexible independent of the overall labour demand.
3.8. Solutions of behavioural economics and its use for unemployment
“The truth about preferences is obvious once you take off your economists’ hat and think like a human” (Rabin, 2001)
Akerlof extends the Neo-Keynesian idea explaining that macroeconomics must be based on behavioural considerations such as “reciprocity, fairness, identity, money illusion, loss aversion, herding and procrastination help” (Akerlof, 2001) since every decision taken by the economic agent is influenced by his behaviour. Some economists called the effect of behavioural economics an increase of explanatory power (Camerer, 2002) some praise the path to more realistic assumptions about the economic actor (Rabin, 2001). The statements have the same result: the inclusions of more realistic notions of human behaviour into economic theory can modify, improve and extend the existing theories of neoclassical economics. Most behavioural theories therefore only supplement already existing theories to make them more realistic and general. They constitute the “natural continuation of the classical research program” (Rabin, 2001).
Historically, psychological discussions have often been related to economic theory. Adam Smith already explained some of the most accepted basics of behavioural economics in his “the theory of moral sentiments” (Smith, 1892) with simple words: “we suffer more … when we fall from a better to a worse situation, than we ever enjoy when we rise from a worse to a better” was the perfect explanation for the concept of loss aversion. However after the neoclassical revolution, psychological explanations constituted the opposite of the focus on clearly constructed and steady modelling. The evolution to cognitive psychology, which considers the brain as information processing device instead of a stimulus-response machine, brought the subject closer to the logic of economics. It was however only in the 1980s when compelling experiments of Kahneman and Tversky proved the psychological influence in the theory of risk, uncertainty and intertemporal choice that economists stated to show more interest for the area (Kahneman & Tversky, 1979). What started with a range of experiments that helped to distinguish behavioural explanations from standard economic explanations developed into a methodology which applied psychological insights to economics without being excessively restricted by experiments (Camerer, 2002).
In the adoption of human behaviour in economics models especially choice making and the attitude to change are of interest. Standard preference theory assumes that choices are made “reference independent” and not affected by the individual position in that moment. In chapter 4.8 we will however show that the way in which choices are presented, called the framing effect, has a strong influence on the preference over the choices given to the agent. Another former market failure that can be filled by behavioural theories is the unsatisfactory adjustment of personal choices, if another guess is already provided, called the anchoring effect. In an choice experiment, subjects were asked whether their certainty equivalent for a gamble was greater than or less than a randomly chosen number and were asked for their actual certainty equivalent for the gamble (Camerer, 2002). The outcome showed that the subjects related their choice unconscious to the given random anchor-number. These and more experiments show that preferences over choices cannot be represented pre-defined sets of indifference curves because humans dislike losing consumption much more than gaining another.
An extension to the classical model has been the focus of behavioural economics on change. Matthew Rabin even stated that “economists still haven’t recognized how pervasive and fundamental is the role of changes.” (Rabin, 2001). Changes are the basis for the difference in psychological factors: becoming rich, not just being rich, can often be the source of major happiness; once humans get used to the situation of being rich, they become as happy as when they were poor and might even fear that they become poor again. This type of relationship of two states falls under the category of reference-dependent preferences. For every situation must however be argued whether current endowments, past endowments or social comparisons are taken as reference points.
Another closely related modification to classical theory is the abolishment of the exclusively self-interested economic agent. Most agents are strongly influence by their social customs and are even concerned about other people’s well-being, namely altruism. This altruistic preference adds utility to the personal utility function as a spillover effect of someone else’s utility function. The existence of strong welfare states such as Germany, where there is high demand for fairness and equity, can be explained with this theory.
Many other theories such as intertemporal choice, preferences under uncertainty, bounded rationality and expectancy theories have equally influences standard economic models and established more realistic economic theory.
Psychology has also help to understand human decision making over preferences. Maslow already illustrated in the 1960s that individuals must satisfy first their lower needs before considering higher ones (Maslow, 1970). Karniol and Ross provided a stronger goal classification with grating highest importance to satisfaction goals such as hunger, sex and sleep. Secondly enjoyment goals such as entertainment must be fulfilled (Karniol & Ross, 1996). Only then come achievement goals as good employment and high skills and preservation goals such as a good health and own possessions. Not only the interplay between these different goal but also their current importance must be considered when trying to understand the complexity of individual decision making, as further explained in chapter 4.9.
To make use of psychological reasoning in economics discussions we must focus on a steady balance between simplified models and generality of explanations. The next subchapter will therefore focus on unemployment in behavioural economics to prepare the basis for the explanation of the behavioural factors in the principal agent setting of our model.
3.8.1. Behavioural theories and unemployment
One of the most fundamental problems of economic discourse is the creation and reduction of unemployment. The classical school argues that every unemployed worker could theoretically find a job if he would be willing to reduce his reservation wage under the current market clearing wage. Only the false expectations of the agent create the unemployment in the school’s view and therefore is all unemployment voluntary (Akerlof, 2001). It further argues that periods of increasing unemployment can be caused by declining aggregate demand that is not adopted into the expectations of the workers that do not adopt their demanded nominal wage and in doing so create unemployment.
In the support for the use of behavioural economics Akerlof, Rose and Yellen have however shown that, following the classical reasoning, voluntary quits should have equally risen in time of increasing unemployment if workers would no longer be satisfied with payments below their expectations (Akerlof, Rose, & Yellen, 1988). The analysed data however reflects even a countercyclical behaviour of unemployment and quits, meaning that less people voluntarily leave their jobs in times of high unemployment. The efficiency wage theory delivered the explanation for this behaviour and the existence of involuntary unemployment. As explained in 3.2.1 classical theory states that higher payments ensure that worker have something to lose if they are fired, which motivates them to work harder. Another, more psychological explanation however argues that human instincts transform the employer-worker relationship into a relationship of gift-exchange (Akerlof & Yellen, 1990). Workers are therefore given a higher payment as a gift for which they return voluntarily harder work. The research in this field has shown that the theory of gift-exchange with its positive utility from exchanges even without further strategic options such as reputation building, finds stronger support than the original version (Camerer, 2002). The same analyses shows that employed workers deprive utility from increasing wage levels, which suggests that wages are a source of self-esteem. This reasoning also supports the fact that unemployed worker gain self-esteem if the work for their benefits.
The intertemporal substitution of leisure and labour explains the steadiness that unemployment creates: If wage rates are low, workers should work short, if they are high they should work much (Camerer, 2002). The reverse functions for unemployed individuals: the higher the benefits, the more leisure he can afford and the less effort he puts in finding a new job. Stronger and empirically tested arguments for the support for the negative effect of idleness on the utility function of the unemployed will be provided in the following chapter.
3.9. Conclusion
This chapter has facilitated the argument for the use of behavioural economics in the discussion about the use of a transitional state to decrease unemployment. Unemployment is created by not only the inflexible hiring and firing conditions on the demand side, which are mostly caused by political decisions, but also by the lack of skills, or rejection of underemployment in welfare states on the labour supply side. Three structural causes for unemployment from the labour demand side were discussed more deeply in 3.2: Firstly, wage rigidity causes a positive effect on work effort but creates involuntary unemployment for outsiders. Secondly, it strengthens the power of labour unions in wage bargaining which results in an increase in wage levels. Finally, we have shown that minimum wage laws theoretically decrease the competitiveness of firms but empirically do not have an influence on the unemployment rate. Subchapter 3.3 and 3.4 have shown that unemployment benefits and the duration of unemployment are strongly influenced by the behaviour of individuals on the labour supply side. High unemployment benefits create low opportunity costs for the individual who experiences an incentive gap between compensation and low paying jobs. This is empirically exemplified by the correlation of the average unemployment time and the eligibility for benefits. We have furthermore shown in 3.4 that most of the total duration and cost of unemployment is attributed to long-term unemployed who constantly lose qualification and skills.
Subchapter 3.5 applied behavioural explanations to solve the malfunctioning of the Phillips curve and consequentially the NAIRU in representing reality by explaining the concept of individual resistance to nominal wage cuts and ignorance of variables that seem unimportant to individual decision making, such as the inflation rate. After this application we briefly discussed the difficulties of macroeconomic theories to explain the phenomenon of unemployment and argued that only behavioural elements such as the irrationality of agents are able to explain reality better. To further explain this statement, subchapter 3.7 uses behavioural explanations to account for cyclical, seasonal, frictional and structural unemployment. The cause of frictional and structural unemployment is strongly based on psychological reasons. Asymmetric information, the unwillingness to mobility and change, lack of abilities and qualifications as well as the willingness to wait-unemployment are only few of the mentioned behavioural causes of unemployment in 3.7. We have also argued that the search for solutions should originate in behavioural ideas: Investments in the acquisition and adaptation of skills to the continuously changing economic environment need to be of highest importance to be able to compete successfully in the labour market. Moreover institutions need to focus on the decrease of search time, faster allocation and decrease of information asymmetries for the individual job-seeker to increase the re-employment rate. Technological change and changing environments demand for further education, retraining and a decrease of geographic distance of the unemployed to work. We have shown that programs that fill seasonal job vacancies with unemployed could be used to increase the possibility of reintegration of the unemployed since they increase mental stability and self-consciousness.
Subchapter 3.8 has shown that the inclusion of more realistic notions of human behaviour into economic theory can modify, improve and extend the existing classical theories. Theories such as framing, anchoring and altruism have successfully helped classical models to improve their applicability. We have also shown that the discussion about unemployment should not focus on situations but on attitudes of change or costs of effort to change: The current and past endowments as well as social comparisons are reference points to individuals that are about to change their situation.
The next chapter will therefore establish arguments for the assumption that the change from unemployment to employment is connected to higher psychological “cost of effort” than the change from a transitional state to employment.
4. The behavioural features in Identity
4.1. Introduction
This chapter defines, based on empirical literature, the behavioural theories which are used to create a behavioural cost factor in the model in chapter 5. After having shown that behavioural elements improve the functioning of economic models, we will establish an argument for behavioural costs of effort to leave a state, which will be used in a principal agent model in chapter 5. These behavioural theories will be applied to the introduction of transitional state systems. However we first explain the behavioural characteristics of employment and unemployment and the psychological influences the states have on the individual. Subchapter 4.3 to 4.9 will then use the most applicable behavioural theories to argue that changing states from either unemployment or transitional state to employment carries a behavioural cost. We will furthermore show that the cost of effort originating from changing ones state differs in size between changing from unemployment to employment and changing from the transitional state to employment because the differences in the behavioural element are smaller in the transitional state and employment. The more similar characteristics of the transitional state and employment will then be used as one single cost factor in our model in chapter 5.
4.2. Behavioural differences of unemployment and employment
Blohmke identifies psychological losses that are tied to the change to unemployment. Some of these are the loss of daily structure that comes with the loss of work, the loss of economic security and economic satisfaction, the loss of individual, career, and social perspective, and the loss of recognition of other people, connected to the shortfall of social contacts with colleagues (Blohmke, 2005). Furthermore the loss of work as a sense of life and possibility of satisfaction of productive needs, the loss of the feeling to contribute and have some sense to society and the provider-role loss in the family contribute to a strong change in the mental behavioural stability when unemployed.
Other studies of stress-coping concepts of illnesses have shown that the announcement of loosing a job leads already to severe psychosomatic problems and health impairment for the individual and his family. The rate of headaches, insomnia, digestion troubles, heart diseases, high blood pressure strongly increases in this group. When entering state U, these rates increase even more. Brenner (Brenner, 1979) comes to the conclusion that an increase of the Unemployment rate by 1% increases the mortality rate by 1,9% in total. Breaking the number down states that heart and circulation mortality increases by 1,9%, cirrhosis of the liver mortality by 1,9%, suicides by 4,1%, murders by 5,7% and imprisonments only by 4%. (Brenner, 1979).
An example for the influence of one’s identity on unemployment can be found in minority groups. It is generally accepted that the higher poverty percent of 23,6 in 2000 under African Americans compared to 7,7 percent under the white US American population is connectable to their long history of discrimination (Akerlof, 2001). The problems related to the group of Africans American extend beyond unemployment to seven times higher crime rates (hrw.org, 2005), drug and alcohol addiction, welfare dependence and female headed household. Since all these strongly interconnected effects on minority groups could not be explained by classical theory, developed Akerlof and Kranton (Akerlof & Kranton, 2000) models that explain this phenomenon with psychological and sociological reasoning. In their theory a person growing up in a minority group faces a Hobbesian choice, either to adopt the norms of the dominant culture or to create an oppositional culture. The first choice includes the knowledge that the acceptance level of the members of the dominant group will never be full and the difficulties to adapt to the other environment that might be in conflict with ones background, decreasing expectations of any success.
The second Hobbesian choice available is to adapt to the historically determined, often oppositional, identity (Akerlof, 2001). Since an oppositional culture reflects what the dominant culture does not reflect, this identity is in the American culture determined to achieve the opposite of the American dream of “everything is possible” namely “constant disappointments” which often ends in unemployment.
A study of the effect of prison population size on the crime rate (Levitt, 1996) supports the identity theory and argues that the negative externalities of imprisonment and formation of the crime-identity stirs future crime and by far outweighs the positive effect of decreasing current crime rates. The investment into stronger policies against crime would in Levitts opinion be better invested into identity improving programs such support for drug and alcohol addicts and public jobs.
To reinforce the positive effect of labour and justify the assumption on costs of effort to change its state taken in the model, the following subchapters will focus on important behavioural and psychological theories to show the same effect on the cost of effort of a transition into another state. These costs to change are lower from a transitional state into employment than from unemployment without work into employment.
4.3. Reference Dependent Mental Models
Classical economic theory uses a simple utility maximisation agent with stable, well-defined utility functions. More realistic approaches however model with social preferences and behavioural theory such as path dependency, identity formation, bounded rationality and loss aversion.
Choices are made strongly reference dependent, influenced by the current mental model or the network surrounding the individual. Examples for this are people that tend to reject offers to reciprocate unfair treatment in the Labour market and reject offers because the person dislikes inequality. (Dufwenberg & Kirchsteiger, 1999) This indicates that work has a strong influence in the behaviour of individuals. Work is a social factor and a prerequisite of social organisation and structure. It has not only a strong influence in the relation of people in society and the network in which they live, but also on the personality of the person. The change from an employment state to unemployment carries psychological and physical consequences that can only be understood when the significance of work on the social setup in which the agent lives is correctly valued.
Mental Models are the set of thought processes of humans, mostly trained by external influences and adopted decision making processes of others. We translate external events into internal models and reason by using these models. Mental Models can “translate the resulting symbols back into actions or recognise a correspondence between them and external events.” (Craik, 1967). They are not the sentence memorised fact that we receive from another source but of situations as the person perceives or imagines them (Johnson-Lard, 1983). Easier described mental models are “thoughts in memory of how things work and how they are put together … or the more powerful form of internal memory”. (Norman, 1990)
However these models can adopt and change over time. Dedre Gentner and Albert Stevens describe in their book “Mental Models” that mental models can be “contradictory, erroneous and change according to the situation and the time” (Gentner & Stevens, 1983) meaning that they are flexible and depend on external conditions.
They can depend on particular situations, can be based on the basis of general knowledge, can be inductions but can also easily be overruled by specific information or experiences to the contrary (Minsky, 1975).
The mental model of an unemployed person is strongly influence by his lack of information and his motivation to find a new job. Assuming that most unemployed suffer from some depression and lack of trust in the job finding process, the mental model does not fit the system. As the graph of the Japanese Ministry of Health shows there is a strong relationship of male suicide rates with the rate of unemployment, which reflects the abrupt change of mental models that a person experiences. The dependence of the two rates only reflects the strong influence of the identification and reference with work on willingness, happiness a motivation to live. Mental Models are interconnected with scenarios of hypothetical or future events, which also break if the employment situation changes unexpectedly (Tversky & Kahneman, 1973). These findings support that the change into another state is connected to a high cost and even thought the literature discusses mainly the change out of employment into unemployment it is logical that the psychological effects would be less for a change of the agent between two more similar states such as a transitional model and employment.
illustration not visible in this excerpt
figure 18: Suicide and Unemployment in Japan
4.3.1. Path dependency, Social customs and steady states as lock-in
Path dependency, social customs norms can all be understood as parts of mental models having the same, above described, effect. Path dependency is the relation of an action today to some past history. This concerns mostly entire sequences of decision-making and not only one event. The outcome of a path dependent process is often different than the rationally expected outcome.
One cause for path dependency can be a lock-in situation, a theory usually used in marketing, which can be applied to the networks which connect individuals. Individuals refrain from making trades that they consider economically advantageous because of the consequences of loss off reputation among the rest of the community. Its classical example is the VHS video recorder that won the market over Betamax even though experts considered Betamax as the superior technology. The network of VHS tapes had already established a base of users with VHS players which created an entry barrier for Betamax and a lock-in of consumer in VHS (Liebowitz & Margolis, 1995). For the theory of decision making this implies that decisions are often not taken on the basis of superiority but depend on the network that surrounds the decision maker and on the barrier to enter another state. Similarly to the discussion about the formation of norms and habits Akerlof argues that social states create steady states that are stable even though they are not expected (Akerlof, 1978). The earlier mentioned payment of efficiency wages are an example for such a steady state which creates a market failure.
Fairness and social preferences are closely connected to this mental path dependency. People sometime chose to spend their wealth to reward those who have helped or who need support. The individual received for this social utility (Camerer, 2002) which can in further behavioural extensions even create fairness equilibria in the game theoretical prisoners dilemma (Rabin, 1993). Related to social utility exists Akerlof’s theory of social customs. It describes the existence of multiple equilibria with steady states that are consistent if an individual is “sanctioned by loss of reputation for disobedience of the custom” (Akerlof, 1978). A social custom is an act of which the agent performing it has utility depending on the beliefs or actions of other members of the community (Akerlof, 1978). The likely evolution of social customs constantly creates undermining beliefs that provoke more disobedience of other individuals which in the long run causes the erosion of the belief and the disappearance of the custom. However, if the utility of the agent depends strongly on the beliefs or actions of other members of the community, disobedience is more harmful than the utility gained from breaking the habits and the custom stabilises. Moreover Akerlof includes the loss weakening of the custom effect if the numbers of believer decrease. The strength of the social custom plays an important role: a strong custom or lock-in may still hold a steady state equilibrium if the number of disbeliever increases or a single exit might already decrease stability if the influence of reputation is weak. Furthermore the number of members in the group plays a significant role. To establish a significant influence of a social custom, a “critical mass” has to be reached, similar to the critical group that needs to be established in network economics to create network externalities (M. Katz & Shapiro, 1986). A more recent study, conducted by Lindbeck, Nyberg and Weibull (Lindbeck, Nyberg, & W. Weibull, 1999) on social norms and economic incentives, confirms that an individual’s choice of labour and leisure depends not only on the after-tax wage and the level of public transfers, but also on the accompanying fraction of the population that receives the benefits.
The same result was found by Lindbeck, Nyberg and Weibull in their analysis of the incentives to work of ones own work. The larger that the population was adhering to this rim, the more intensely is it felt by the individual who adheres or breaks the norm (Lindbeck, Nyberg, & W. Weibull, 1999). It is likely that an increase in the number of people who receive welfare benefits weakens the social norm to live off one’s own work. Moreover, individuals who live off public transfers may over time come to value their leisure more. In an empirical study from the Netherlands, Engbersen et al. (Engbersen, Schuyt, Timmer, & Waarden, 1993) found that a majority of long tern unemployed had stopped looking for work an that more than half of these had done so because “they had found other activities to give meaning to their lives: hobbies, voluntary work, or working in the informal economy.” Even though it would be rationally expected that unemployment is not persistent it therefore creates a steady state.
In the social identity view, when people categorise themselves as an ingroup member, the ingroup serves as a reference for social comparison, and people adopt the prototypic ingroup attitudes and beliefs as their own (Wood, 2000). Agreement from others that are similar suggests that the shared attitudes reflect the reality and the objective truth. Since we assume that the intensity of the norm depends on the number of people adhering to it and that living of social benefits systems is less embarrassing if more people do likewise we can easily conduct that the costs in terms of utility of changing from the state of unemployment, in which leisure plays a greater role for the total utility, to employment, in which work yield utility per se, is higher than from a transitional state that has the some norm as the employment state to employment.
The balancing of social custom and profit motive has been subject of Arrows “Models of Job Discrimination” (Arrow, 1972) for whom discriminatory tastes, such as the earlier mentioned inefficiency of minority employment, are based on partly self-implied discriminatory norms. These inefficient tastes are preferred by all concerned groups. The punishment that the agent receives when he does not obey the code is form of a loss of reputation. Arrow expands this thought to the question why discriminatory tastes are stable in the long-run, or in other words a lock-in.
Social standardisation occurs within groups that strengthen the underlining behaviours and mental models of the state. Strong steady states reflect themselves as more difficult transitions to another state which indicated in figure 17 by the thicker lines around the more steady states U and E. Akerlofs model can be interpreted as to see the stable state of “everyone obeys the social custom” as the unemployment state, the state “no one obeys the custom” as employment his result that any other state is unstable as the transitional state. This way it can be argued that the transition out of an unstable state is easier than the transition out of a stable state. This interpretation could be checked with behavioural factors but goes beyond the scope of this paper.
Norms and habits also grow in strength with the time the individual adheres to them. Based on the assumption that frequent performance of a behaviour leads to the formation of a habit or norm and that habits can influence behaviour independent of attitudes and intentions, Bentler (Bentler & Speckart, 1979) proposed that the frequency of past behaviour should be added to predictive models. This confirms that the frequency with which behaviour has been preformed in the past tends to correlate with later actions (Ajzen, 2001).
Furthermore exists in developed countries a social norm against living off other people and a corresponding normative pressure to earn one’s income from work (Elster, 1989) which also in part explains the high negative utility received from not working. Taris (Taris, 2002) supports this effect in a study of the relationship of mental health and unemployment in the Netherlands with data of 229 young unemployed. The perceived characteristics of unemployment, caused by the above mentioned normative pressures, affect mental health which in turn influences the intention to look for a job, amount and type of a job-searching behaviour, and the chances of finding a job. Mental ill-health therefore reinforces the custom, norm or steady state by forming an obstacle that needs to be overcome by the individual if changing his state (Feldman, 1996).
Resembling all these interdependent models under the heading Mental Model shows that, given an actual low proportion of transfer recipients of around 10%, the disutility of living on the work of others is high, but not as high as in a transitional state where the mental model of working individuals is predominant.
4.4. Attitude formation, expectancy value and attitude change
Attitudes are learned predispositions to respond in a favourable or unfavourable manner toward a psychological object (Lutz, 1978). Ajzen & Fishbein extend the evaluative response from favourable and unfavourable to attribute dimensions such as harmful and beneficial, pleasant and unpleasant, as well as likable and unlikable (Ajzen, 2001). An attitude consequently creates prejudgments about situations. Seekings (Seekings, 2002) has shown in his studies of differences between attitudes of employed and unemployed in Cape Town with qualitative data that there are a number of issues on which the employed and unemployed hold contrasting attitudes. He also suggests that attitudes are influenced by the labour market status of other household members but cannot provide clear evidence.
One conceptualisation of attitude is the expectancy value model (Fishbein & Ajzen, 1974) which argues that any behaviour depends on the expectancies of the value of the goal. The behaviour chosen by the goal-oriented individual is therefore the one with the highest expected probability and value in the attribute dimensions. The individuals are in this theory considered as goal-oriented because they, according to their beliefs and values, choose an action to achieve a specific goal. In the expectancy value theory, behaviour is a function of expectations, which is the belief that performance depends on effort, instrumentality, the belief that outcome depends on performance, and outcome value, the value attached to achieving the outcome. Shepperd and Taylor show in an experiment in which they manipulate instrumentality while holing expectancy and value constant, that individual effort in collective settings are often unidentifiable and redundant and that the link between personal effort and achieving the desired collective outcome is weak (Shepperd & Taylor, 1999). This creates low motivation and shows that social loading and free-riding can be reduced by assisting the individual to value the behaviour or outcome and that the outcome is dependent on their performance. Attitudes depend thus not only on the belief or probability to achieve the expected goal but also on the evaluation of influences the individuals believes to have on the outcomes.
Meaning arises spontaneously and inevitably as we form believes about topics. Each of these believes relates the topic with an attribute. The individual then forms an overall attitude on the topic, which depends on the subjective weight of the attitudes and the interaction between them. Believes are constantly accessible in the memory of the individual and therefore influence the attitude formation at any given moment.
The expectancy value model assumes that automatic attitude activation is regularly used to create a quick conscious response in one’s set of believes (Fazio, Sanbonmatsu, Powell, & Kardes, 1986). Bargh et al. even argue that automatic attitude activation is used even without an explicit goal to make of evaluative judgments (Bargh, Chaiken, Govender, & Pratto, 1992).
The most realistic notion however considers a joint effect of affect and cognition in the creation of responses (Bower, Sahgal, & Routh, 1983; Chaiken & Stangor, 1987). Evaluations are influenced by cognition as well as affect but the strength of either factor strongly influences the created attitude towards the issue. Ajzen distinguishes between thinkers, who base their attitude formation mainly on the their believes about the attitude object, but not their feeling towards it, and the feelers, who have the tendency to base their attitudes on their affect or feeling and not on the cognition (Ajzen, 2001).
The possibility to change or influence the creation and formation of attitude and believes towards work is of major importance for our discussion about the influence of a transitional state on an unemployed individual. According to the expectancy value model (Ajzen, 2001) chronically accessible believes supply the basis for the present attitude but appropriate factors can make certain beliefs more available. Depending on the value influence of these extrinsically motivated changes of belief, the current attitude can shift in any direction (Ajzen, 2001). If we assume now, that the transitional model of 1-Euro-Jobs or any other forced transitional labour situation changes the factor of the valuation of future work by increasing the motivation to find better work or improving the self-assessment of one’s own skills, the belief on the former costs of effort of searching for a job are higher than the costs that are connected to the newly created belief.
The finding of Lunt and Kokkinaki that involvement of the individual in the objective that he is supposed to choose, such as the creation of a product or in our case the involvement in work, highly increases his attitude towards the object, supports this suggestion (Kokkinaki & Lunt, 1997). These transitional forced involvements are similar to forced implementation intentions which facilitate the target to attain difficult goals (Ajzen, 2001) for any individual that connects high negative utility to the process of reaching a goal. If the transitional state is connected to an attitude change these postulations support my assumption that the disutility from leaving state T to state E is lower than from state U.
It must however be noted that the possibility to change attitudes is strongly negatively related to attitude strength. It is reported that the strength of attitudes varies over the life cycle, with greatest strength being displayed in midlife (Ajzen, 2001). If the attitude towards the leisure of unemployment is significantly higher than the positive effect of the transitional state on the attitude towards work, the costs of effort will not be lower under the transitional state to employment system, abbreviated as (U-T)-E, than under the unemployment to employment system, abbreviated as U-E.
Another factor that strongly influences either positively or negatively the ease of attitude change is whether the stimulus to change originates from a public or private influence. The common assumption is that when public and private judgments differ in accuracy, privately expressed ones are generally more trustworthy because public expressions may be biased to achieve social motives. However findings of Wood (Wood, 2000) show that public influences enhance perceived accountability for judgements which means that people give more thoughtful, reasoned responses in public. The dual-mode processing models of persuasion (Ajzen & Fishbein, 2000; Petty & Wegener, 1998) states that informational accuracy seeking motives can lead to extensive processing and enduring attitude change or sometimes also to more superficial processing and temporary change. If one however considers that public settings provide individuals with surveillance over their response whereas private settings trigger normative influences such as expectations of another person, we can conclude that enduring attitude change is stronger when activated by a public domain such as the state. In addition to this trigger function of enabling people to evaluate and appraise stimuli from another source in their environment, attitudes also serve for a personal social adjustment caused by their social relation motives (D. Katz, 1960). These social adjustments might cause an unemployed worker to accept the norms of the working society more easily when forced to do transitional work, their public domain at work and their social adjustment to other workers aids in the process of adopting a working attitude. People with low intrinsic motivation or low abilities, characteristics that can be found in the group of unemployed, base their attitude judgments on easily available attributes of a source or situation that are evaluated via efficient processing strategies or differently expressed fast and easy response strategies (Wood, 2000). Consensus in groups therefore implies correctness for the unemployed who adapts to the majority position which reflects the easiest form of attitude change. Baron et al. (Baron, Vandello, & Brunsman, 1996) supports this by stating that individuals who are only moderately motivated to work use heuristic-like strategies of relying on the estimates of others, despite the fact that they could determine the correct answers themselves.
Concluding one can say that attitudinal ambivalence, the existing presents of positive and negative dispositions towards and attitude issue always exists and there will always be a conflict between cognition and affect in forced transitional labour. The conflict can be between multitudes of objects: the cognition to be able to find a better job and the affect to be forced to work, the cognition to increase or stabilise his skills against the affect of the lost leisure or any other internal conflict. However unemployed individuals with low abilities without difficulty change their attitudes towards work when placed in a group with the mindset of workers. According to protection motivation theory (Prentice-Dunn & Rogers, 1986) a transaction of the unemployed from unemployment without work to a transitional state with forced work has a positive influence on the acceptance of the recommended coping strategy with the situation and changes the negative behaviour in the old state because of the combination of threats and the provision of effective strategies for change.
4.5. Control, Self-efficacy and self worth
A wide range of theories discuss the individual valuation of tasks and the creating of motivation and formation of effort. Eccles outlined four valuations to assess tasks, attainment value, intrinsic value, utility value and costs (Eccles, 2002). Attainment value is the relevance of engaging in a task for confirming relevant aspects of one’s self-schema or simply the importance of doing well on the task. Intrinsic value is the enjoyment the individual gets from performing the activity or the subjective interest the individual has in the subject. Thirdly, utility value reflects how well a task relates to current and future goals, such as career goals and thereby captures the most extrinsic reasons for engaging in a task. Eccles also includes costs into the setup of valuing tasks and defining one’s own motivation. These costs reflect the negative aspects of engaging in the task, such as performance anxiety and fear of both failure and success, as well as the amount of effort needed to succeed and the lost opportunities that result from making one choice rather than another.
Motivation, success and effort are all strongly dependent on psychological self-assessments. The influence of these self-assessments on work motivation and the importance of feedback and expectancies is widely discussed (M. V. Covington, 1984; Craske, 1988; Klein, 1989). In the attempts to create a meta-theory in the field of motivation to work, that includes the most accepted psychological processes that are related to work motivation, Howard Klein suggested a integrated meta-theory that provides a general framework for understanding work motivation (Klein, 1989). This framework uses control theory as the integrating tool and explains other theories in it. The next paragraphs will discuss control theory next to two other main concepts: self-efficacy and self-worth theory. All three facilitate the discussion of the psychological differences in a transitional work state and in idleness.
4.5.1. Control theory
According to control theories, humans expect to succeed in their endeavours to the extend to which they feels in control over their successes and failures (Eccles, 2002). If we cannot assess the level of control over success and failure we undermine our motivation to work on any task (Kahn, 1990). Klein’s meta-theory of work motivation uses the control theory as an integrating framework since its dynamic structure allows the integration of other theories (Klein, 1989). For the topic of work motivation, especially feedback, goal-setting, expectancy and attribution theories are of interest. The feedback loop in control theory is the main building block and consists of four elements: the referent standard, an input function, a comparator and an output function. The example of an thermostat explains the mechanism: The referent standard is the temperature the thermostat is set at, the input function the element monitoring the current room temperature, the comparator is the mechanism that compares the current and desired temperature and the output function is the heater or air conditioner. By looping between the input function and output function the comparator levels the system to the given signal of the referent. Even though human control systems are more complex, they work with the same functionality of feedbacks to achieve some goal. If we consider the example of our unemployed individual, the input function is the information the unemployed perceives about his current situation, such as personal problems and lower payments. He then compares this information with the given referent standard and forms a perception whether he is satisfied with the performance or situation or not. If this comparison is unsatisfactory he will take corrective actions to improve his situation. The behaviour of the individual therefore strongly depends on the referent standard which on the other hand depends on the mental model and state in which the individual currently is. This makes the difference between the two systems obvious: The old system gives the signal that a input of low income and much leisure is the normal standard, the new system however signals that work is the satisfactory level.
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figure 19: feedback loop in control theory
In an attempt to describe goal directed activity, Ellen Skinner describes basic distinctions among constructs of control such as the difference between objective control, subjective control and the experience of control and the relation between agents, means and ends of Control (Skinner, 1996). The interrelationship between these three factors, which has already been used by Bandura, lets her separate many of the already existing theories in three groups.
The means-ends relation for example represents the expectation that particular causes and pathways through which control is exerted can produce certain outcomes. The relation is the basis of terms such as response-outcome expectations in Bandura’s model (Bandura, 1977) as well as the earlier mentioned term instrumentality (Ajzen & Fishbein, 2000) and many others such as the locus of control (Mitchell, Smyser, & Weed, 1975).
The connection of agents, the individual concerned, and the ends or outcome prescribes however the prototypical definition of control (Skinner, 1996). If an individual is convinced that he can fulfil a task he is said to have personal or perceived control or a sense of control. Like in the means-ends relation, the agent-ends relation represents what others have called expectancies of success, outcome estimates, control expectancy and perceived control.
The last relation between Agents and Means represents the extent to which means are available to the agent. If the means or capacity beliefs are not available, the agent does not recognize that he can achieve the goal.
This control theory framework implies a strong synergy between the agent-means belief and the means-ends belief. In a discussion about the motivation or effort of individuals to search for work it implies that the agent is not only able to see the means at hand, such as available job offers, but that we also consider that he believes that he can reach the outcome of finding a job by applying with high effort and showing the necessary self-confidence.
If we now consider the difference of the U-E system with the (U-T)-E system we can argue that exactly the latter, the means-end relation, strongly differs: Control theory focuses attention on the self-regulation of behaviour (Klein, 1989). The U-E model suffers under the means-ends expectation that unemployed have lower expectations of the system. Only the new system they change into the framework of working people and understand that their work can easily enhance if they show high effort to find a better job. This way they regulate their own effort level by a stimulus of an external source.
As Ellen Skinner already states, an overall framework of control theory above all other psychological motivation theories can never replace theories such as self-efficacy as a theory to describe people’s convictions that they posses a controlling response (Skinner, 1996). The next two parts will consequently explain the theory of self-efficacy and self-worth in more detail to understand the belief individuals have about themselves which help to understand the psychological differences in the two states.
4.5.2. Self-efficacy theory
Self-efficacy theory concerns people’s judgement about their ability to perform actions that prospective situations demand (Whyte, Saks, & Hook, 1997). According to the self-efficacy theory of Bandura, peoples judgements of self-efficacy partly determines what activities to undertake, how many resources to spend on effort and how long to persist in the face of obstacles or difficulties (Bandura, 1982). He defined self-efficacy as ‘individual’s confidence in their ability to organize and execute a given course of action to solve a problem or accomplish a task’. It is therefore a social cognitive model of motivation that is focused on the role of perceptions of oneself (Eccles, 2002).
Self- efficacy assessments are judgements about how we perform in specific situations. Whyte, Saks and Hook have demonstrated that these judgements contribute to motivation across a wide variety of situations and presented findings that positive self-efficacy assessments lead people to expend greater effort and to persist longer to attain their goals. (Whyte, Saks, & Hook, 1997). Discrepancies between goals and achievements are either motivating of deflating depending upon people’s perceived capabilities to attain their objectives. Individuals who do not believe they possess the appropriate skills are easily discouraged when their performance does not meet expectations.
The impression made by the literature on self-efficacy is that high self-efficacy is a characteristic desirable to possess (Gecas, 1989). Overall results show that judgements with high self-efficacy have a significantly positive effect on motivation to persist and motivation to take part in actions (Bandura, 1982; Whyte, Saks, & Hook, 1997). Outcome expectations always have to be considered into the discussion about self-efficacy. If one believes that certain behaviour produces a certain outcome, the outcome expectation is defined. If however the degree of anticipated difficulty in performing the behaviour is set, the self-efficacy is defined (Bandura, 1977; Eccles, 2002).
Goldsmith, Veum and Darity demonstrate in their research on the psychological impact of unemployment why unemployment is likely to influence individual self-efficacy. As the duration of the current unemployment spell lengthens, the likelihood of strong self-efficacy declines (A.H. Goldsmith, Veum, & Darity, 1996). The longer the duration of unemployment, the more likely is a reduction of self-efficacy as well as a self-perception and helplessness. Furthermore, the perceived psychological effects of unemployment can account for the difficulty that many of the unemployed experience in trying to locate employment. If the idleness however is decreased by a transitional state system, some of the psychological difficulties are diminished and the change to employment facilitated.
It can be predicted that individuals who posses low self-efficacy in decision making will less frequently than others invest resources and take risks in an attempt to turn a unfavourable but stable situation into another direction (Ajzen, 2001). These individuals are also easily discouraged by failure. Since we have shown that unemployment posses a lower self-efficacy that is created by their situation, we can infer that a transitional state does not carry the mentioned discouragement. A change from the transitional state with higher self-efficacy to employment is therefore easier than a change from unemployment with low self-efficacy.
4.5.3. Self-worth theory
Self-worth and self-efficacy are conceptually distinct, since self-worth is a judgement of self-satisfaction whereas self-efficacy is a judgment of task-specific capability (Whyte, Saks, & Hook, 1997). More precise, self-worth is the tendency to establish and maintain a positive self-image (M. V. Covington, 1984). Covington & Omelich demonstrated that both college students’ most-preferred attributions for success are ability and effort. The most-preferred attribution for failure was however not trying (M. V. Covington & Omelich, 1979). This is caused by the so called failure avoiding strategy of self-worth where individuals will not try, precisely because trying and failing threatens their ability self-concepts. Humans avoid tasks in order to maintain both their own sense of competence, and others’ conclusions regarding their competence (Eccles, 2002).
Goldsmith et al. find that both young men and woman who in the past spent time unemployed fulfil the positive correlation of duration of unemployment and lower level of self-worth or self-esteem (A. H. Goldsmith, Veum, & Darity, 1997; Jahoda, 1981). Following their argumentation supports the proposal that shorter duration of unemployment strongly decreases the negative effect on self-worth. Jahoda’s analyses shows that the inactiveness of unemployment triggers the negative effect, which would be overcome with a transitional state.
However it needs to be mentioned that other research have found no effect of unemployment on self-worth (Shamir, 1986) but only the reverse effect. This would mean that individuals with low psychological self-worth are more sensitive to the change to unemployment than those of high self-esteem. Further research would have to be done to support our assumption that is in line with the first mentioned proposals of Jahoda and Goldsmith et al. that a transitional state has a different effect on self-worth than unemployment.
4.6. Mental health
The negative influence of mental health in terms of depression and psychosomatic complaints on unemployment has been documented by various studies. These studies mostly conclude that the missing respect from others and missing order in life creates stigmatisations in individuals who expect a different surrounding for themselves (Catalano, Aldrete, Vega, Kolody, & Aguilar-Gaxiola, 2000; Murphy & Athanasou, 1999). Others show that mental ill-health is characterised by regular feelings of powerlessness, hopelessness, apathy and low self-worth (Schaufeli & Van Yperen, 1992; Taris, 2002; Taris, Bok, & Caljé, 1998).
Unemployed who feel unable to influence their situation because of low self-worth or a feeling of powerlessness will be less inclined to search actively for a job. The created extended duration of unemployment on the other hand causes depression which results in lower intrinsic motivation to change one’s situation. This creates a self-reinforcing circle that is difficult to break. If the individual is however set in a working state it improves his mental health if he considers it as a intermediate situation to employment (Hamilton, Merrigan, & Dufresne, 1997). Studies of the Great Depression identified detrimental psychological effects associated with unemployment, including dysfunctionality and apathy (Lazarsfeld 1971). This evidence is supported by studies of Banks and Tiggeman who found that mental health of young people and industrial workers improves when they regaining employment (Banks 1982; Tiggeman 1984, Lahelma 1992).
Working individuals are less prone to depression and other illnesses because they have more opportunities to establish social network and achieve satisfaction and power over these networks (Hamilton, Merrigan, & Dufresne, 1997). This interaction with work colleagues in the same situation improves self-worth and decreases mental illnesses. Murphy et al. emphasises empirically that the effect of the actual change from unemployment to employment has a significant effect on mental health (Murphy & Athanasou, 1999). In collecting and comparing scientific literature on the affect of the change from employment to unemployment together with empirical date they find that there is evidence of a depressed mental health score being associated with unemployment. Distress levels fall following re-employment, which implies that job losses provoke psychological distress (Murphy & Athanasou, 1999). Because the majority of literature concludes that the activity of working has a positive effect on individuals, we can conclude that the overall effect of partial re-employment, such as in a transitional model, creates higher general well-being. It has furthermore been shown that stronger social support such as the transitional state systems and increased physical activity lead to improved mental health (Hamilton, Merrigan, & Dufresne, 1997). This improved mental health by activity is also associated with a higher index of employability.
It must however be mentioned that most literature concentrates on youth unemployment because adults over 40 are much stronger influenced by the comparison of the re-employment job with their former job. This creates a sample that shows only low direct correlation of unemployment and mental health (Bjorklund, 1985). However, the direct effect of unemployment and the change to any working state is reflected in the result for young individuals. Working in any form such as the transitional state therefore appears to improve mental health which suggests that interventions to improve mental health by the individual’s activity may enhance work force productivity by higher re-employment rates.
4.7. Bounded rationality and loss aversion
The applicability of decision making with rational choice is strongly questioned in economic theory. Most decisions are taken on intuitive reasoning rather than rational behaviour (Kahneman, 2002). Bounded rationality reflects the fact that people do not know how to estimate their own preference and if valuing it, misperceive it. Daniel Kahneman distinguishes in his Nobel Prize Lecture (Kahneman, 2002) between intuitive and deliberate thought processes. In the intuitive model, judgements are made automatically and rapidly like a reaction to a stimulus whereas the deliberate mode is controlled and slower. Intuitive decisions are however prone to systematic biases.
People suffer from informational constraints and psychological erroneous believes such as loss aversion. The fact that a one-time gamble about losing 1000EUR and winning 1100EUR is less preferred than taking 300 independent rounds of the same gamble reflects this loss aversion. Tversky and Kahneman provided a group of individuals with two differently expressed answers which rationally reflected the same result in an experiment on riskless choice (Tversky & Kahneman, 1991). The expression of the option has, as the results reflect, a significant impact on the option chosen by the individual. Nearly all participants chose the option that was associated with the lesser evil, even though the result was the same. These participants therefore did not use rational but intuitively bounded, spontaneous decision making. Human decision making is therefore often based not on the rational utility maximisation but on routines, intuitions and habits. Bounded rationality is therefore caused by the systematic failure in decision making where individuals use predefined response sets influenced by the social background and identity instead of pure rationality based on causes and effects of a specific situation (Kahneman, 2002).
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figure 20: A typical value function (Tversky & Kahneman, 1986)
In the expected utility model (Schoemaker, 1982) the individual forms his opinion by a three step process, cognition, evaluation and selection. The first is used to associate the situation with a former experience to find a sense in the situation. Then he evaluates the possible alternatives with his own preference and possibility of the consequences which each alternative carries and thereby calculated the maximised expected utility. In Kahneman and Tversky’s prospect theory, the individual does however not maximise with full information but with incomplete information and limited perception which are the main causes of bounded rationality (Kahneman & Tversky, 1979). Humans therefore value their gains and losses with these incomplete references which cause the value function to be concave for gains and convex for losses. Furthermore losses are steeper than gains with defines the expression loss aversion. When individuals anticipate an aversive outcome, they try to avoid it or to reduce its negativity. If they cannot avoid it, they may attempt either to delay it or to hasten its onset (Karniol & Ross, 1996). Since the evaluation step is influenced by complex strategic psychology, the selection is often strongly influenced personal behaviours.
Vendrik and Woltjer have shown in their analyses of happiness and loss aversion that a very significant concavity of life satisfaction exists in negative relative income (Woltjer & Vendrik, 2006). This concavity is caused by the loss aversion to negative relative income. Since the level of one’s relative income is more important than the absolute level, happiness does not increase if the entire society’s income level rises. The explanation given is that as the individual’s income and day-planning falls short of the reference group, it becomes increasingly difficult to participate in the social activities of the reference group. Furthermore, unemployed suffer under the social comparison effect which causes them to prefer any working condition. The loss aversion against the unemployment state can be diminished if the individual quickly regains in the transitional state the status of worker and remains in a similar reference group as in employment. The bounded rationality therefore on the one hand causes the unemployed to remain in the unemployment status because of his new reference group. If he however changes to the transitional state and regains work, his happiness might increase.
4.8. Framing
Framing theory reasons similar to bounded rationality, namely that humans decide in every situation anew how to choose from the given options. The framing individual establishes studies and analyses situations by remembering former situations and using unconscious reasoning (Tversky & Kahneman, 1986). Other than bounded rationality, framing does not use stepwise analyses to reach a decision but defines a preliminary valuation of the situation with frames and chooses the actual decision in the spectrum provided by the frame. Nonetheless, if the individual has chosen his frame that he considers best fitting for the situation, he uses utility maximisation to find the best solution, as it is done in prospect theory for bounded rationality. The example of the choice between being killed in an car accident and surviving in a wheelchair shows the effect of framing: Most people choose to die in the accident because the fear depression and disorientation, however people who actually survived accidents and cope with wheelchairs show after an adoption period no less happiness as before the accident (Frank, 1989). Similar to most of the behavioural theories mentioned above, framing is strongly linked to other theories. For example, expectancy-value formulations can account for framing effects through variations in the likelihood of relevant goals and values, as well as through the variations in the evaluation given to them (Ajzen, 2001).
Framing theory illustrates that human decision making depends on the situation and condition the individual is in. Humans decide every time anew, even if a similar decision was taken before, what option to choose but in a predefined frame of relevance which identifies the sense of the situation. Furthermore, framing appears to highlight the relevance or importance of existing knowledge structures and values (Wood, 2000). The characteristics of the specific situation and the behaviour and type of other actors in the situation define the frame chosen and actual outcome. Frames are therefore definitions of situations, ordered by the identity and personality of the individual and influenced by communication, behaviours and speech. Frames change not only with evolution of a conversation but also with the changed cognition or information processing of the individual.
Frank reasons that every intelligent policy decision must include not only consider the absolute level of consumption but also the appropriate frame of reference within the group of consumers to find the optimal (Frank, 1989). His reasoning can easily be translated to the situation of unemployment. Once the initial adjustment to the unemployment has been made and the individual is considered as long-term unemployed, lower consumption level and especially lower activity has become the norm. Since high motivation to search for a job have been lost over the adoption period and the unemployed has become unenthusiastic to actively search, the reverse effect to create his motivation is very effort costly. A transitional state recreates the working norm and constructs the appropriate working frame of reference for the individual.
Framing theory also supplies direct support to the assumption that the change from one state into another is connected to a behavioural cost. In a study whether cognitive mapping decreases or eliminates the framing bias, created by changes in the way of presenting a problem, Hodgkinson et al. find that the reformation of the presentation frame has a significant impact on the choice made by the individual (Hodgkinson, Bown, Maule, Glaister, & Pearman, 1999). By creating a situation that requires less effort from the individual to reach the wanted decision, the unwanted effect of frames can be overcome. Future research could provide a cognitive map of unemployed individuals to explain their current situation in terms of their previous experience and expectations of the future. This check would prove our reasoning that a working frame, as provided by the transitional state, increases the re-employability.
4.9. Intertemporal choice and time discounting
This subchapter will extend the behavioural theories explained until now with the coping of individuals with intertemporal choice, which are tradeoffs between current and future rewards (Laibson, 1999). As mentioned before, humans imagine various futures, then develop plans to achieve their goals while avoiding negative outcomes (Karniol & Ross, 1996). Guided by their current behaviour, experience, self-knowledge, mood and expectation, they decide for one option. In every just mentioned psychological factor plays time duration and tendency to focus on the future an important role. People may sometimes decline to think about the future, and consider only a small subset of possible futures (Karniol & Ross, 1996). This occurs because they do not contemplate futures that are incompatible with their current value or preference or wrongly estimate completion time of effort needed (Buehler, Griffin, & Ross, 1994). Furthermore they can prioritise goals over their self-control process. Goal choices generally reflect a “positive time preference”, the motivational pull of goals with immediate outcomes over the discounted value of distal goals (Karniol & Ross, 1996). Even when individuals do decide to pursue distal outcomes, the value of such outcomes may spontaneously decrease during goal pursuit, making distal outcomes more similar in value to proximal outcomes that were of lower value originally (Laibson, 1999). As the subjective values of proximal and distal outcomes converge and become more similar, the pursuit of long-term goals becomes more difficult. Individuals differ in their use of psychological transformations to render the subjective values of proximal and distal goals. It has however been shown that people are unable to assess their future likes and dislikes accurately which causes some to become unhappy and depressive with their own decisions made on the basis of expected utility since they underestimate the actual value of some actions (Shoda, 1990). It is therefore difficult that individuals not only determine how they feel about the distal goal now but also forecast how they will evaluate it in the future.
Individuals may often see themselves forced to focus on relatively immediate objectives. Since immediate goals exert a stronger motivational impact on behaviour than distal goals, people are motivated to determine their decision with the focus on the short-run (Bandura, 1999). This suggests that distal goals often need extrinsic help to increase the importance of proximal goals (Karniol & Ross, 1996).
Employment decisions strongly reflect the above mentioned complexity. People may psychologically transform free choice situations into no-choice situations in order to sustain their priorities over time (Karniol & Ross, 1996). Seeing themselves as compelled to go to work, if they for example take part in a transitional state system, may relieve individuals of the daily temptation to stay at home and creates the earlier described correction between short run and long run goal preferences. Others might exhibit naivety about their future preference reversal and fail to foresee these reversals of foreseen future utility (Laibson, 1999). A forced transitional state can help them to engage in investments such as education and the consistency of skills that will maximise their future utility. The previous chapters have shown that the transitional state reflects more values and preferences to future employment than unemployment, which causes the discounting of future preferences to improve.
4.9.1. Hyperbolic discounting
Standard discounting utility models use exponential discounting functions to relate future actions to current decision making problems. The constant discounting rate of exponential discounting functions rarely reflects reality and experimental evidence (Laibson, 1999). Most experimental evidence suggests that the discounting rate declines with the length of the delay horizon. Köszegi states that people tend to overweight immediate pleasure relative to what is in their long-run benefit (Köszegi, 2004). Findings as above on intertemporal preferences show that discounting in the short run is higher than in the long-run (DellaVigna & Paserman, 2004). A person might prefer one apple today to two apples tomorrow. However, it would be puzzling to find him prefer one apple in 100 days to two apples in 101 days, which illustrates simple hyperbolic time preference.
The model of hyperbolic discounting of motivation reflects that people overweigh their current pleasure compared to their long-run benefits (Köszegi, 2004), which reflects the earlier mentioned inclusion of intuitive and behavioural reasoning in human decision making processes.
The reasoning of hyperbolic discounting also explains the decision making of unemployed individuals. The intertemporal trade off today of finding a low-paying job and higher utility from leisure while enjoying the unemployment compensations strongly affect the type of discounting. The difference between the chosen search-effort level by the unemployed and the actual search offer can be substantial (DellaVigna & Paserman, 2004). This is mainly cause by the overvaluation of current leisure and the hyperbolic discounting of future utility from working.
The effect of individuals with a high reservation wage of search-effort who put even less effort into in exiting unemployment is enormous. Their incentive structure to take a new job is strongly diminished by the misinterpretation of the importance to remain one’s own skills and signal the motivation to work (Laibson, 1999). The higher the leisure provided by the state is today and the lower the pressure to search actively for a job is, the stronger discounts the unemployed the value of future employment. If the individual is however in a working state such as the transitional state, his hyperbolic discounting becomes weaker because of the similarities of lifestyle and norms as well as the ease of switching from the transitional state to employment.
4.10. Conclusion
This chapter has created a strong argument for the inclusion of a behavioural cost element into the modelling with transitional state systems. Behavioural theories have shown that individuals experience different effects in the change from unemployment to employment than in the change from a transitional state to employment. Most of the theories discussed have shown strong support for lower behavioural costs of changing in the system with a transitional state.
The analysis found inter alia that the distinct reference groups in unemployment and the transitional state as well as the difference in mental stability and health call for the inclusion of a behavioural element in models representing unemployment. Furthermore the improved attitude towards work as well as the more realistic expectations of the importance of future employment justify the use of distinct costs of effort to change states in the two systems. The following chapter will use the established argumentation that the behavioural cost to change one’s state in the transitional system is lower to create more powerful support for the usage of these systems.
5. A moral hazard framework extended with a behavioural element
5.1. Introduction
This chapter will compare the system of change from unemployment to employment with the system of change from the transitional state to employment. The moral hazard modelling framework has been chosen to represent the conflict of individual utility maximisation and the society’s cost minimisation. Society wishes to activate the highest effort of the unemployed to increase the probability of re-employment while minimising its total costs. The unemployed on the other hand maximises his utility function which includes the utility from being unemployed or in a transitional state, the utility from being employed and a behavioural cost element that represents the effort to change from one state into employment. The model will use this setup to show that the lower costs of effort in the transitional system have the same effect in the optimal payment structure as an increase in after-unemployment wage. Since after-unemployment wage is in reality fixed by the private market and benefits are rigid due to equity considerations, we can show that the implementation of a transitional system has a positive effect on re-employment over the above mentioned behavioural theories.
First we will explain the overall setup of the model in more detail and demonstrate its working in a graphical representation. Next, the assumptions taken are clarified and the included variables defined. We will then elaborate on the exact setup of the model, demonstrate its working in a game tree and present its calculations in a general form. After the calculations the results are interpreted and the findings discussed.
The result illustrate that a less sanctioned transition from T to E with lower costs of effort than from U to E has the same effect as higher monetary incentives Abbildung in dieser Leseprobe nicht enthalten or lower unemployment benefits Abbildung in dieser Leseprobe nicht enthalten. Translated into the case at hand it would mean, that the Hartz-suggestions change for example the psychological settings of the unemployed and his work condition in such a way that it is easier for him to reach employment.
5.2. Framework
The Hartz Commission has, as explained above, put an emphasis on the alteration of the system to avoid the negative effects of unemployment on workers that will from here on be called agents with regards to the principle agent theory (Kunz & Pfaff, 2002). With this focus we create a framework for a model that is able to compare the influence of a behavioural element called “identity” in the old system of employment and unemployment with the new system with a forced transitional state. The cost of effort of changing are assumed to be the only difference of the two systems to clarify its effect and expressed by the behavioural element “Identity” which is usually not included in standard economic theory.
To clarify the effect of behavioural differences as described in chapter 4 such as reference-dependency, social customs and bounded rationality, as well as attitude formation, control and mental health and self-efficacy theories, a new behavioural element called “identity” will be established. This element will be a collective term for similar effect of the discussed theories in the comparison of the two systems. The strength of these behavioural theories in the utility function determines how easy it is to exit the state. A mentally greatly locked-in person will for example be very averse to changing his state and therefore carries a higher cost of effort to changing its state.
The labour market of the model presented has three states employment (E), unemployment (U) and the transitional state (T) with one player who either changes from U to E or from T to E. Provided that the intrinsic transition out of unemployment is connected to a sufficient loss of utility when leaving U or T, created by the behavioural difficulties described in chapter 5, every transition is connected to a cost of effort of changing one’s state. In the state U the Identity factors of unemployment are followed. If a person of this Identity is now moved to the state of employment, he or she experiences disutility that is expressed as cost of effort that depends on the identity U: Abbildung in dieser Leseprobe nicht enthalten. States U and T have a cost of effort of changing out, assuming that the individuals are reluctant to change because of their mental models, path dependency, bounded in their rational decision making process or any other of the behavioural factors described in chapter 4. State T represents a point where the unemployed worker is forced to do a transitional job he did not choose such as under the “1-Euro-Job” model in Germany. This state has been created under the new reasonability assumption that it is better for individuals to work something than to be jobless. This positive influence of the transitional state on future employment is in our model represented by a lower cost of changing from state T to E Abbildung in dieser Leseprobe nicht enthalten, providing that workers are drawn to state E. Chapter 4 already clarified that the costs of changing is lower in the system with a transitional state than in the system with an unemployment state.
The states could be plotted on the behavioural elements in identity and income like the following:
illustration not visible in this excerpt
figure 21: Identity force fields
Abbildung in dieser Leseprobe nicht enthaltenThis graph represents the difference of the change from U to E and the change from T to E. The similarities of the behavioural identity factors in E to the ones in the transitional state T is symbolized by the ease of transition from any point in the transition circle into employment and the larger overlap of the circles. This lower cost is represented in the model by the factor Abbildung in dieser Leseprobe nicht enthalten. The arrow from an average point in T into E shows that the behavioural elements on the vertical axis are similar in the two states. A straight line would signify that Abbildung in dieser Leseprobe nicht enthalten.
The transition from an point of unemployment to employment carries however a higher cost of effort caused by the difference in behavioural elements. As we have shown in chapter 4, unemployed individuals often suffer from lower control over their situation, lower self-efficacy and a higher time discounting, as explained in the subchapters 4.5.1, 4.5.2 and 4.9 respectively. Since all these behavioural factors have to adjust to the norms of in the employment state, the change carries a “identity” cost represented by y in the graph (note that y will be used for another variable in the actual model). The cost of effort to change states for this system would therefore be Abbildung in dieser Leseprobe nicht enthalten.
For example, an individual that has been unemployed for a longer period has a different mental model than a person that is forced to take a minimal wage job soon after he lost his previous job. When changing to employment, the individual in the transitional state does not have to adopt his mental model as much as the individual in unemployment. This difference is captured by the costs of effort to change in the utility function of the agent.
The goal of the following model is to create a moral hazard framework for the relation of the influence of different costs of effort to change one’s state and the optimal support level or payment for employed.
5.3. Assumptions
The situation is modelled as a Moral Hazard Principal-Agent problem based on the general setup of Possajennikov (Possajennikov, 2003): one party takes an action that affects the payoffs for both parties but the action is not observable by the other party. The parties suffer from incomplete information and can only agree on a contract depending on the consequences of actions.
Moral Hazard theory derives from analysis of the insurance market where the principal, the insurance, tries to offer contracts to the agent whose actions are unobservable. The model presented below allocates the role of the principal to the government and the agent to the unemployed individual. The government needs to take actions without being able to observe the level of effort the agents will put into searching for a job. Their minimisation of the total costs will therefore be constraint by the condition that the agent chooses high effort.
An Agent that puts no effort into searching for a job or take part in any prescribed activity always receive the reservation utility of all other actions denoted by X, which is the unemployment benefit 2.
No consideration of Fixed Costs
The costs for the principal connected to the different systems (transitional or direct) are assumed to be the same were connected to the old system. Additional, partly setup related costs that are currently strongly increasing the overall costs of the Hartz reform are not included to keep the model simple. Even though more money is spent on services the overall predicted effect should be cost saving (see 2.5) by gaining efficiency in job placement. Reality however shows that the price of placement has by far overshot expectations, whereas the overall quantity of placement decreased through the new incentive systems and faster turnover rate. This means that the government is actually spending more on state T which in the Long Run might be levelled by the decreased overall cost and increased income through taxes (Borstel, 2006). Since all this is considered to be highly speculative, it will not be included in the model.
Assumptions on costs and benefit payments
The cost structure of the government is connected to the duration of unemployment, a relationship that could be potted on a classical exponential function: The longer the worker is unemployed the higher costs are connected to his unemployment for the government. To simplify the model however, we will concentrate in the old model on the choice of medium or long term unemployed to find employment and in the new model on the point after the choice between accepting a job at the PSA or accepting to receive the low benefit of the “unemployment benefit 2” (see graph 1, 3.7.4).
Unemployed and employed workers receive their income from different sources. Whereas employed receive wages for which they still pay taxes, the unemployed receive unemployment benefits and extra granted benefits. In the model, we represents income of the agent in form of either unemployment benefits with other privileges when in state U Abbildung in dieser Leseprobe nicht enthalten, or unemployment support with the payment received through the PSA for jobs done (Abbildung in dieser Leseprobe nicht enthalten) when in state T. We assume here that
Abbildung in dieser Leseprobe nicht enthalten
since all the receivables of the agent are costs to the society. This argues that the new system (U-T)-E carries a higher cost to society than the old system U-E. We take this assumption even though the earlier mentioned expenditure forecast for the Hartz model predicts a total cost saving. However reality has shown that it has become more expensive. We will show that higher costs of the new system create a tradeoff between higher Abbildung in dieser Leseprobe nicht enthaltenwith lower Abbildung in dieser Leseprobe nicht enthaltenand on the other hand lowerAbbildung in dieser Leseprobe nicht enthaltenwith higher Abbildung in dieser Leseprobe nicht enthalten. Lower costs of the new system will create a further incentive to implement the new system instead of a tradeoff.
The profit function of the principal is simplified to a cost function holding everything else constant. Society will therefore always minimise the costs of the payment to the working labour Abbildung in dieser Leseprobe nicht enthaltenand the payment of unemployment benefits Abbildung in dieser Leseprobe nicht enthalten or Abbildung in dieser Leseprobe nicht enthalten, depending on the system discussed. We will however assumer that Abbildung in dieser Leseprobe nicht enthalten is exogenous because society can only alter the payment of unemployment benefits over its government. Influence on privately paid wages will be excluded from this model and taken as a constant.
The costs for the principal are in the old system U-E: Abbildung in dieser Leseprobe nicht enthalten, endogenous
The costs for the new (U-T)-E system: Abbildung in dieser Leseprobe nicht enthalten, endogenous
The transfer payment if the U or T state are left in E is: Abbildung in dieser Leseprobe nicht enthalten, exogenous
Negative value V in the cost function reflects income for the society
The value that the state gains from having the individual in the labour condition or in the transitional state is also included in the cost function to show that the total costs cannot be minimised by paying everyone unemployment benefits. This value Abbildung in dieser Leseprobe nicht enthaltenincludes the higher taxation for the employed to pay the unemployment benefits of the unemployed. The value is included to avoid the argument that the government minimum cost is granted by paying only unemployment benefits because a high amount of paid unemployment benefits minimise the factorAbbildung in dieser Leseprobe nicht enthalten that reflects the income of the society over the work force. The factor is unimportant for the reasoning of the model and will only show up in the basic cost function of the state.
Assumptions on effort and probabilities
If the agent is searching for employment, the probability of gaining employment differs in his effort level and in the state he is in. To simplify will we consider only two effort levels, high and low: Abbildung in dieser Leseprobe nicht enthaltenand Abbildung in dieser Leseprobe nicht enthalten. In each state we assume that Abbildung in dieser Leseprobe nicht enthalten.
The probability of being employed after high effort is Abbildung in dieser Leseprobe nicht enthalten and of being unemployed Abbildung in dieser Leseprobe nicht enthalten.
After low effort, the probability of being unemployed is Abbildung in dieser Leseprobe nicht enthaltenand of being employed Abbildung in dieser Leseprobe nicht enthalten.
Furthermore we do not assume that the probability of gaining employment is higher from T than from U for the same effort level, to focus on the effect of the costs of effort in the Agents utility function. Further research could include the difference of probabilities in the two systems and evaluate the balance between the cost of effort depending on Identity and the higher probability to reach employment in the new system on the basis of an extra cost factor in the cost function of the principal.
Assumption on the Identity I function and costs of effort
This model concentrates on the effect of the difference in cost of effort to change from U or T to E which is caused by the Identity factors. As mentioned before, the cost of high effort are less in the transitional (U-T)-E system, than in the old U-E system Implementation costs will however in our model be considered to fixed costs and therefore of no importance. Lower costs of effort connected to the transitional state system are therefore not directly linked to other costs. Costs of effort to change depend on the behavioural Identity factors: Abbildung in dieser Leseprobe nicht enthalten which corresponds to the disutility of a change in states.
There exist three Identity categories for the agent that can be in the model: Abbildung in dieser Leseprobe nicht enthalten, representing the identity of an individual in employment, Abbildung in dieser Leseprobe nicht enthalten in unemployment and Abbildung in dieser Leseprobe nicht enthalten in the transitional state. The Identity factor corresponds to the three categories, thus
Abbildung in dieser Leseprobe nicht enthalten
The influences of these “identity” behavioural factors on an individual depend on the influence of each factor, as explained in chapter 4, on the individual in the Category. For example:
Abbildung in dieser Leseprobe nicht enthalten
MM: influence of mental models such as path dependency, lock-in and identity formation
BR: influence of Bounded rationality and loss aversion
F: influence of Framing
ITC: intertemporal choice and time discounting
AF: Attitude formation, expectancy value and attitude change
CS: Control, self-efficacy and self-worth
Since we assume that the disutility of the U-E transition is higher than the disutility of the (U-T)-E transition we will assume that:
Abbildung in dieser Leseprobe nicht enthalten
As shown in chapter 4, the costs of low and high effort in the transitional system are both lower than low and high effort in the old system.
5.4. Setup of the model
To analyse whether the assumption that lower costs of effort depending on the Identity factors have a positive influence on the system, the principals cost function will be minimised subject to the effort constraint of the agent. Once the optimal unemployment benefit Abbildung in dieser Leseprobe nicht enthaltenor Abbildung in dieser Leseprobe nicht enthaltenand the optimal wage levelAbbildung in dieser Leseprobe nicht enthaltenare found in relation to the costs of effort, we will show that the alteration of the cost of effort by creating the (U-T)-E system can have the same effect as a change in the optimal exogenousAbbildung in dieser Leseprobe nicht enthaltenor endogenousAbbildung in dieser Leseprobe nicht enthalten.
Cost function of the principal
The Principal in this model is represented, as stated before, by the entire society. The comparison of the two systems does not require a total profit function of the principal. We have chosen to minimise the cost function of the government to explain how the optimal payment structure, subject to the minimised cost of the system, reacts on changes of costs of effort.
Abbildung in dieser Leseprobe nicht enthalten
These cost functions represent the direct change from U to E and the indirect change over a transitional state, respectively. Society carries both the costs of the unemployment benefit as well as the costs of wages of the individual, depending on the probability of gaining employment with high or low effort.
The last subtracted term only ensures that the costs of the principal cannot simply be minimised by paying only unemployment benefits in the optimal. It simply represents the value gained by the person for high probability because the subjective functions below ensure that the agent chooses high effort and thereby ensures the consistency of the cost function. It will however drop out in the calculation and optimisation.
In the model we will use the general form to concentrate on the effect of the costs of effort to change:
Abbildung in dieser Leseprobe nicht enthalten
Utility function of the Agent
Abbildung in dieser Leseprobe nicht enthalten
Abbildung in dieser Leseprobe nicht enthalten
These functions state the Utility function of an individual showing high and low effort respectively. Abbildung in dieser Leseprobe nicht enthaltenrepresents the identity factor of an individual in the U or T state correspondingly and Abbildung in dieser Leseprobe nicht enthalten the associated costs for a person with this Identity that he carries if he changes out of his state. The utility from income and other compensations are represented in the y. The disutility from changing ones state is separately represented in the subtracted cost element. These two functions are presented in the general form, meaning it is not differentiated between the transitional state system and the unemployment system to show the result of changes in c.
5.5. Context in the moral hazard framework
The principal minimises his costs subject to two constraints. The first constraint, the agent’s participation constraint, forces the individual to take at least any effort to search for employment instead of relying on the reservation utility. The second, the incentive compatibility constraint, ensures that the agent chooses high level of searching instead of optimising for his low effort:Abbildung in dieser Leseprobe nicht enthalten.
The principal’s costs function will be minimised:
Abbildung in dieser Leseprobe nicht enthalten
We have to bear in mind that the Principal could not set Abbildung in dieser Leseprobe nicht enthaltenfor Abbildung in dieser Leseprobe nicht enthalteneven if efforts would be observable since we assume it to be exogenous. For this reason we prove that the effect of lower costs of effort to change have the same effect as a imagined increase of Abbildung in dieser Leseprobe nicht enthalten.
The cost minimisation is subject to:
Abbildung in dieser Leseprobe nicht enthalten
The participation constraint of the agent sets that any utility reached by participating is higher than his reservation utility.
And subject to:
Abbildung in dieser Leseprobe nicht enthalten
The function above represents the constraint that the agent chooses high effort to change to employment.
5.6. Decision Tree and optimisation
The moral hazard problem can be visualised in a game tree with society choosing the system which is to be implemented and the agent selecting an effort level. The principal desires the agent to select high effort. In the interpretation of the results we will show that the positive effect of the lower costs of effort will increase the value of the new system with the transitional state that the optimal value is constituted in the new system with the agent choosing the high effort level.
illustration not visible in this excerpt
figure 22: game tree visualisation of the model
To visualise the relation of the optimal Abbildung in dieser Leseprobe nicht enthalten with the cost Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten, the Lagrange function is used to find the optimum payment or expenditure Abbildung in dieser Leseprobe nicht enthalten. The resulting optimal levels are then derived for Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthaltento investigate the relation between the variables.
Lagrange to find the optimalAbbildung in dieser Leseprobe nicht enthalten:
Abbildung in dieser Leseprobe nicht enthalten
5.7. Calculations
We will simplify the model as follows:
Costs of effort:
Abbildung in dieser Leseprobe nicht enthalten
From the assumed Abbildung in dieser Leseprobe nicht enthaltenfollows that
Abbildung in dieser Leseprobe nicht enthalten
Since Abbildung in dieser Leseprobe nicht enthaltenis a constant in the model, we can express the costs of effort as a fraction of this constant.
The probabilities of finding employment or staying unemployed, with high and low effort respectively, are defined as below. Consider that we assume that the probabilities for the two systems U-E and (U-T)-E are equal to focus on the effect of costs of effort:
Abbildung in dieser Leseprobe nicht enthalten
With Abbildung in dieser Leseprobe nicht enthalten
➔ Abbildung in dieser Leseprobe nicht enthalten
To simplify any form of expenditure of the society and income of the agent Abbildung in dieser Leseprobe nicht enthalten is assumed.
The optimisation becomes therefore:
Abbildung in dieser Leseprobe nicht enthalten
St: Abbildung in dieser Leseprobe nicht enthalten
St: Abbildung in dieser Leseprobe nicht enthalten
From the inequality constraints of the optimisation function follows thatAbbildung in dieser Leseprobe nicht enthaltenand Abbildung in dieser Leseprobe nicht enthalten.
The calculation of the optimalAbbildung in dieser Leseprobe nicht enthalten andAbbildung in dieser Leseprobe nicht enthaltenwith Lagrange:
Abbildung in dieser Leseprobe nicht enthalten
Now the Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten equated:
Abbildung in dieser Leseprobe nicht enthalten equated:
Abbildung in dieser Leseprobe nicht enthalten
Abbildung in dieser Leseprobe nicht enthalten equated:
Abbildung in dieser Leseprobe nicht enthalten
Abbildung in dieser Leseprobe nicht enthalten solved for Abbildung in dieser Leseprobe nicht enthaltenandAbbildung in dieser Leseprobe nicht enthalten:
Abbildung in dieser Leseprobe nicht enthalten
Abbildung in dieser Leseprobe nicht enthalten solved for Abbildung in dieser Leseprobe nicht enthaltenandAbbildung in dieser Leseprobe nicht enthalten:
Abbildung in dieser Leseprobe nicht enthalten
5.8. Results
To study the relation of the optimal Abbildung in dieser Leseprobe nicht enthaltenwith cost of effort to change its state Abbildung in dieser Leseprobe nicht enthaltenthe optimal Abbildung in dieser Leseprobe nicht enthaltenis calculated by equating theAbbildung in dieser Leseprobe nicht enthalten:
Abbildung in dieser Leseprobe nicht enthalten
To see how the optimal e reacts on changes in a, we take the derivatives:
Abbildung in dieser Leseprobe nicht enthalten
Both solution confirm the assumption of the negative relationship between a and Abbildung in dieser Leseprobe nicht enthalten. Holding all other variables constant and considering that Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten as well as that Abbildung in dieser Leseprobe nicht enthalten it is easily visible that also the numerator is positive.
Likewise the second function holds since the probability of an agent with low effort to reach employment is always smaller than 1: Abbildung in dieser Leseprobe nicht enthalten and we assume that Abbildung in dieser Leseprobe nicht enthalten.
To see whether the cost of effort of changing its state d has the same negative relationship with Abbildung in dieser Leseprobe nicht enthalten, meaning that a decrease in costs of effort for an agent with low effort has the same effect as a increase in Abbildung in dieser Leseprobe nicht enthalten we differentiate the optimal Abbildung in dieser Leseprobe nicht enthalten for d too:
Abbildung in dieser Leseprobe nicht enthalten
These results clearly show that the relationship does not hold for agents with low effort. The first function is positive in both numerator and denominator which would lead to a positive relationship. The second function is positive too becauseAbbildung in dieser Leseprobe nicht enthalten.
We can therefore conclude that a lower cost of effort to change its state has only the same influence as an increased Abbildung in dieser Leseprobe nicht enthalten if the agent chooses high effort which becomes obvious when we consider that one of the constraint binds the agent to choose high effort levels.
To study the relation of the optimal Abbildung in dieser Leseprobe nicht enthaltenwith cost of effort to change its state Abbildung in dieser Leseprobe nicht enthalten the optimal Abbildung in dieser Leseprobe nicht enthaltenis calculated by equating the Lagrange functions solved forAbbildung in dieser Leseprobe nicht enthalten:
Abbildung in dieser Leseprobe nicht enthalten
To see now how the optimal Abbildung in dieser Leseprobe nicht enthalten reacts on changes in Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten we take the derivatives:
Abbildung in dieser Leseprobe nicht enthalten
Similar to the results of the analysis on Abbildung in dieser Leseprobe nicht enthaltenthe denominator of the function has to be positive and the nominator becomes negative if the assumptions Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten are fulfilled, resulting in a positive relationship of Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten. A lower unemployment benefit has therefore in our model the same effect as lower costs of effort of changing his state, which corresponds with expectations.
Similarly it can be shown that the system does not function for agents with low effort:
Abbildung in dieser Leseprobe nicht enthalten
5.9. The essence and interpretation of the results
The results satisfy that an decrease in the cost of changing its state for an agent with high effortAbbildung in dieser Leseprobe nicht enthalten has the same effect as a increase of the Abbildung in dieser Leseprobe nicht enthaltenor a decrease of Abbildung in dieser Leseprobe nicht enthalten. This translates my proposition that a decrease of the costs of effort from Abbildung in dieser Leseprobe nicht enthalten of the U-E system to Abbildung in dieser Leseprobe nicht enthalten of the (U-T)-E system,Abbildung in dieser Leseprobe nicht enthalten, has the same effect as a decrease in the optimally needed unemployment benefit or increasing the optimal after-unemployment wage. The importance of the influence of the behavioural element becomes apparent when we consider that unemployment benefits are relatively sticky because of equity consideration. Furthermore after-unemployment wages can hardly be directly influenced of the society over the functioning of the government because wages are set by the private market and are subject to market failure discussed in earlier chapters.
The result of the moral-hazard model has shown that changes in the cost of effort to change one’s state have the same effect as an increase in after-unemployment wage, which overcomes the problem that wages are assumed to be exogenous because society can not alter the salaries paid by the private sector. If society decides for a unemployment compensation that is not market clearing but equity enhancingAbbildung in dieser Leseprobe nicht enthalten, transferring unemployed into the (U-T)-E system with lower costs of changing to employment creates a way to increase re-employment rates.
Consequently if we replace the subjective costs of effort of changing its state Abbildung in dieser Leseprobe nicht enthalten by Abbildung in dieser Leseprobe nicht enthalten with Abbildung in dieser Leseprobe nicht enthalten the (U-T)-E system requires a lower optimal Abbildung in dieser Leseprobe nicht enthalten and Abbildung in dieser Leseprobe nicht enthalten, if the agent exercises high effort, than the old U-E system.
Using models of motivation, we could argue that the new transitional system decreases the need for monetary incentives to make agents search for jobs since the costs of effort of changing the state are lower from the transitional state than from the unemployment state (Frey, 1993). It could even create a social norm in the group of unemployed that further increases the search-motivation (Schokkaert & Devooght, 2003).
Even if the governments actual costs of Abbildung in dieser Leseprobe nicht enthalten are lower thanAbbildung in dieser Leseprobe nicht enthalten, the positive effect of lower costs of changing the state could increases re-employment or decrease total costs. The necessary condition for the (U-T)-E model, which can be any transitional model such as the PSA work of the Hartz commission, to be welfare improving is therefore that the subjective cost of agent is lower.
5.10. Perspective on the extension and modification of the model
Future discussions not only have to focus on the extension and modification of the currently implemented reforms but also on fundamental changes in the unemployment compensation system. Direct changes are more realistic to implement considering the bureaucracy and politics that are connected to reforms. The discussion of transitional models therefore still offers a large amount of possible theoretical research in the field of behavioural economics.
With the focus on our model, further research could include more realistic assumption on the difference of probabilities in the two systems. Instead of using the same cost function for the principal, different probability values could be used which can be found in empirical literature. The value of probabilities would then improve the informational value of the results. The explanatory power would furthermore increase with the differentiation of the income levels between the transitional state and the unemployment state. However empirical research on the German labour market does not show a certain result that the transitional income is higher.
The moral-hazard problem fits well with the incentive compatibility problem created between the society and the unemployed individual. Other models which represent information asymmetries, such as some game theoretical setups, could however as well be extended to explain the difference in behavioural factors in the two systems. Most importantly the empirical basis of the behavioural factors explained in chapter 4 on the individual in the transitional states needs to be extended to extend our argumentation with numerical values.
6. 2/3 society: the better alternative to transitional states?
Unemployment is generally considered to be an undesired situation of the economy. Current labour market literature and theories of technological change suggest however that the paradigm of full employment cannot be hold in the future.
Economic development and technological change diminish the demand for labour, which must not essentially be seen as a negative development. The current norm that is advocated by the majority of politicians that individual self-confidence and feelings of self-worth are diminished might be a self-inflicted value with a negative effect on development (Lotter, 2005). Full employment has in the German history only been reached once in the time of the economic miracle in the beginning of the 1950s until the 1960. This growth was however based on the victims of the Second World War who strongly diminished the labour force. The industrial revolution started the pursuit for full employment but will also be the end of it. The German production has shifted in the last 50 years from 70% tangible products to 70% intangible products in 2000. Should the increase of productivity proceed by manufacture more with less effort, it will create a society of few thinkers that create the complexity of processes and very few workers for the manual labour. The implication of this separation is already visible today. The thinkers not only decrease the manual work for the workers, but also reinforce the social norm that success can only be reached by showing higher effort than others.
The process of reaching a higher level of productivity is however not a negative development, even if it is accompanied by higher unemployment rates. If a country is in total more productive than other countries, not considering the means of production factors used, the overall standard of living must be high in a welfare state. A strong welfare system of a large amount of workers cause by high automatisation and high productivity is therefore favourable. Estimations of the possible productivity which automatisation could have in Germany have shown that an unemployment rate of 38% could become the norm (Späth & Henzler, 1998). Society could focus more on the adoption of the new work separation instead of emphasising the importance of work for the well being of individuals, which only causes the separation of work that could more efficiently be done by one person and thereby create inefficiency in production that diminishes the competitiveness of a state.
If society adapts to the automatisation and a higher unemployment rate is widely accepted, redistributions of productivity gains grow in importance. Many economists such as Milton Freedman suggest that any citizen of a country should be provided with a base level income or negative income tax that is granted independent of his working situation (Lotter, 2005).
Unemployment can be interpreted as the result of the success of automatisation. The problem for the society will be to accept that unemployment is no longer a unfavourable situation but a situation in which a large part of the population lives to increase the productivity of the entire society. This change, as we have shown in the thesis, would however not be possible because the norms and values of a working society are deeply integrated in the behaviour of individuals and the acceptance for reforms. Furthermore extract political parties and interest groups such as unions their power from the working society and would not provoke loosing votes by lobbying for a higher base unemployment. Even though the two-third society constitutes an interesting mental experiment of a more efficient future state, it cannot be translated into reality. Psychological frames, self-worth and loss aversion creates a steady objection against the actual implementation of this form of redistribution.
7. Conclusion
This thesis has provided support for more inclusions of behavioural elements in discussions and modelling of transitional state solutions to unemployment. The example of Germany has shown that strong welfare systems can create a social norm for the extensive provision of unemployment compensation and therewith cause a decrease of incentives to actively search for jobs and change into any form of employment. However behavioural theories suggest that forcing unemployed into transitional working situations can have a positive effect on overall re-employment, as illustrated in chapter 4.
Transitional state policies transform the idle TV-watcher to a scavenger who is motivated to leave his state and search for employment while remaining at a high level of mental stability, health and skills. Keeping the skills level of the workforce at a high level, even if they are temporary out of work, creates a flexible labour market, as has been shown. The creation of a transitional state is one of the few ways for countries such as Germany to create a competitive labour force. Social welfare countries suffer chronically from strong social standard for wage rigidities, high unemployment compensations, and the caused higher base unemployment. We have demonstrated by taking Germany as an example that transitional states have not only a positive effect on the re-employment over the behaviour of the individual but also a direct effect on the flexibility of the labour market by creating a market for part-time work.
The foundation for the use of behavioural elements in economic discussion permitted us to create a single behavioural element that reflects the collective effect of the change from unemployment or the transitional state respectively, to employment. Chapter 4 firmly based this behavioural cost element on various behavioural theories and created evidence of a significant improvement in human behaviour caused by the transitional state.
The creation of a moral hazard framework that includes the behavioural cost element assisted us to explain the influence of a higher valuation of psychological effects in labour market discussions. The framework was established in a way that included two cost factors that are in reality difficult to alter by policy reforms; namely unemployment benefits and the employment rate. The finding that the decrease of the behavioural cost element, caused by the forcing the unemployed into a transitional state, has the same effect as an increase in employment wage or unemployment benefit, leads us to the conclusion that transitional states might increase re-employment by changing the psychological situation of the individual. The model therefore added value to the theoretical implementation of behavioural elements in incentive compatibility problems. The extension of the framework might even be translated from the example of the psychological effect of transitional states into other areas.
The main problem with the applicability of our argument is that the transitional state can only have a positive effect on the re-employment if the economy provides the jobs that skilled transitional workers can adopt. Moreover the actual transformation of the theoretical transitional state concept to the Hartz reform has become from the perspective of time and costs a larger problem for the German government than expected. The total number of unemployed rises from day to day and the government as well as the opposition encounters no valuable solution; not even in the large coalition that seeks for ways to revise the reform. The new government expects a total payment of about 28 billion Euros for the new unemployment compensation and motivation system, being twice as much as was expected by the Hartz commission (Schäfer, 2006). An interim report of the German Federal Court of Auditors shows a first analysis of the mistakes and calculation errors that have been made in the first month of implementing the Hartz-reform (Bundesrechnungshof, 2006). It reports that not only long-term unemployed but also the job mediators of the PSA are badly educated about what their actual goal for the transitional state is. This basis of PSA mediators have to fulfil and implement the reform but do not know and cannot cope with the new tasks. The testing of skills and analyses of motivation is preformed in a lax way and it is still far too easy for the unemployed to avoid the payment of the unemployment benefit II (Arbeitslosengeld II).
The report also shows the politically most unfavourable result that the saving of the reform appear only in the job placement of short-term unemployed, not the long-term unemployed which have drawn much focus in the Hartz-report. The cost-benefit system does however not include the long-term behavioural advantages explained in this thesis. We therefore suggest that a recalculation as suggested in this thesis is necessary to obtain a more realistic value of the system.
The theoretical aspect of the discussion on transitional states also bears problems. The overall discussion on transitional state still lacks empirical literature that examines the wide array of psychological consequences, such as self-worth and mental health, both during the unemployment state and following reemployment with a transitional state. A framework that creates empirical psychological findings on the changes from unemployment and the transitional state to employment would go beyond the scale of this thesis. Only then could we conclude with more definitive statements that transitional states have positive effects on human behaviours.
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- drs., Master of Science in Economics Fidelius Kuehn (Author), 2006, Why scavengers are better than tv-watchers. An analysis of transitional labour systems for the unemployed from a behavioural economics perspective, Munich, GRIN Verlag, https://www.grin.com/document/62593
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