Fiscal Budget Minimization vs. Social Welfare Optimization Divergence
Expert TheoryReview
Policy evaluations often conflate minimizing government fiscal spending on unemployment insurance benefits with maximizing aggregate social welfare, leading public administrators to over-expand active labor market programs.
Picture this
Imagine a city government trying to reduce its snow-plowing budget. The city could force all residents to spend two hours every morning shoveling public roads for free. While this policy dramatically cuts government spending on snowplows, it inflicts massive time and fatigue costs on citizens, leaving the entire city worse off overall than if the government had simply paid for plows.
What the evidence says
Public unemployment spending is minimized at a 30% program participation rate ($\tau = 0.30$), whereas net social welfare is maximized at a 20% participation rate ($\tau = 0.20$). Expanding participation to 100% increases total public expenditure while generating a 0.13% net decline in social welfare.
- Who was studied
- Indirect inference structural policy simulation on N = 40,403 Danish unemployed workers and 14 county vacancy markets.
- How
- Comparison of the government expenditure minimization objective $C_{UI}(\tau) = u \cdot b + \delta(1-u)\tau c_p$ against the net social welfare function $W(\tau) = (1-u)p + u(\dots) - \delta(1-u)\tau c_p - v c_v$.
What to do
Design public employment policy expansion targets around net social welfare maximization functions rather than strict government budget expenditure minimization.
From the source
"A cost-benefit analysis indicates that government expenditures are minimized when about 30 percent of the workers participate in the activation program, while welfare is maximized when around 20 percent of the workers participate in the program."
816b5187-9076-4043-aba7-184043b2e524-Estimating Equilibrium Effects of Job Search Assistance.pdf