Unemployment Insurance and Experience Rating in a Simple Model of Involuntary Unemployment

Abstract

Standard results in the area of unemployment insurance suggest that experience rating is beneficial because it confronts firms with layoff costs and reduces unem ployment. This article presents a different perspective, suggesting that experience rating may increase involuntary unemployment. A simple model that combines elements of efficiency wage and insider-outsider hypotheses is used to address the issues. Results show that experience rating causes significant wage and unemploy ment effects. Thus, standard conclusions in the experience-rating literature may not easily carry over to models of involuntary unemployment. From a policy perspective, this article suggests that costs and benefits of experience rating should be carefully evaluated, especially when unemployment is involuntary.