In all markets, whether for public or private goods, market failure is seen when resources are not efficiently allocated. The misallocation and inefficient use of resources becomes evident in situations involving unemployment benefits and insurance. This essay will focus on the concept of moral hazard and its impact on the effectiveness of these benefits and insurance. The primary concerns related to moral hazard in unemployment scenarios will be examined, along with proposed strategies to reduce its negative effects.
Market failure occurs when markets are unable to efficiently allocate resources without government intervention. This leads to a decrease in economic and social welfare as well as a loss of production efficiency. In other words, market failure happens when an unregulated market fails to achieve efficiency under certain conditions. There are three specific situations that cause market failures:
Market failure refers to situations where goods and services consumed by everyone are provided, the production of goods involves external costs or benefits, and output is limited by monopolies and cartels. This serves as a justification for government intervention in order to redistribute wealth and income for equity or distributive justice. The government intervenes with the aim of eliminating waste and achieving an efficient allocation of resources, according to the public interest theory.
Government actions can address market failure and achieve allocative efficiency by providing subsidies for unemployment benefits. Unemployment benefits are considered a public good, which means they are consumed by everyone without exclusion and are non-rival and non-excludable. The issue of unemployment is growing, with the CSO reporting a 14.2% unemployment rate in 2012. As a result, a significant number of individuals receive cash benefits without contributing to them, becoming free riders who consume goods without paying for them. People receiving unemployment benefits fall into this category as they cannot pay taxes due to their unemployed status but still benefit from the system.
A free rider problem occurs when certain individuals refuse to pay. Consequently, taxpayers who contribute revenue for these services will assume a greater burden than those who do not contribute. Taxpayers carry the expense of collective risk, leading to ineffective allocation. Economist Paul Krugman defined moral hazard as “any scenario where one person decides how much risk to take, while someone else bears the consequences if things go wrong.” Moral hazard refers to the inclination to take unnecessary risks without facing the repercussions.
The concept of moral hazard arises when one party chooses the level of risk to take on, while another party faces the consequences. In this situation, the individual does not fully take responsibility for their actions. Moral hazard is a type of information asymmetry, where one person has more knowledge than the other. The more informed person acts in their own self-interest. For a market to function effectively, both consumers and producers need to have complete information about prices, quality, and future results.
The freedom to work is a personal choice. However, insurance providers are unsure if an unemployed individual is actively seeking employment. The presence of moral hazard is significant as it allows individuals to manipulate their unemployment status, which ultimately discourages work and decreases the workforce in a country. Detecting this moral hazard proves difficult, leaving insurance providers and beneficiaries unaware of the true intentions of those receiving benefits.
In the context of unemployment insurance, both parties find themselves in a contractual relationship with contradictory intentions. The recipient of the benefit engages in risky behavior, while the insurer remains fully aware, resulting in a market failure. Notably, the amount of money received as unemployment benefit in Ireland is considerably high. Consequently, individuals become less motivated to actively seek employment, as they already enjoy a substantial income. Pursuing work would potentially entail a loss of benefits or a reduction in income due to taxes, which consequently diminishes the incentive for individuals to actively search for employment.
The payment system is designed to prevent Moral Hazard by keeping unemployed individuals motivated to seek employment. The net earnings of employees are influenced by the amount of income tax and social security contributions deducted from their earnings. When someone is unemployed, they receive payments instead. If there is a significant difference between these two amounts, it can affect their motivation to work. A high ratio further increases the risk of moral hazard as it may discourage unemployed individuals from actively seeking employment.
The provision of unemployment benefits may lead to workers reducing their work hours or leaving their jobs due to the payment and duration of these benefits. Furthermore, offering unemployment benefits can create a moral hazard by prolonging the period of unemployment. This occurs because it distorts the relative value between leisure and consumption, resulting in a moral hazard. According to Moffit (1985) and Meyer (1990), increasing unemployment benefits by 10% in the U.S. can result in an average lengthening of unemployment duration by 4-8%. To tackle this problem, adjustments can be made to the benefits provided.
There is evident moral hazard present in this situation as individuals receive significant benefits. Consequently, their motivation to actively seek employment diminishes because they already receive a substantial income without working. They are unwilling to sacrifice their leisure time for job hunting, which has an opportunity cost. Thus, reducing payments becomes necessary to enhance their incentive for seeking employment since lower incomes would adversely affect their standard of living.
Government intervention can create a larger disparity between income earned from employment and unemployment benefits, which can motivate individuals to actively seek out employment. By reducing taxes on income, people are more likely to work and less likely to rely on benefits. Imposing time limits on benefit receipt will increase people’s inclination to work. The enforcement of strict rules regarding the duration of allowable benefits is crucial. Those who remain on benefits for an extended period should face penalties, ultimately resulting in a decrease in the amount received.
Accurate information is crucial to prevent confusion between job seekers and non-job seekers. Failure to follow these rules may lead to a decrease in payment. Generous benefits can create a moral hazard by reducing individuals’ motivation to find employment. This moral hazard is worsened by prolonging unemployment through the substitution effect. Unemployment benefits increase the likelihood of this moral hazard occurring. Therefore, it is important to reduce both the benefits and their duration as a way of addressing this problem. By taking these steps, we can address market failure and establish a more efficient system.
