Thünen-Series of Applied Economic Theory - Working Paper No. 162
Our study compares the efficiency of centralized and decentralized unemployment insurance programs in a state union. We use a model of two countries with collective bargaining for regional gross wages. The labor force and the firms are partially mobile across the member states of the state union, which gives rise to distortive migration incentives. If unemployment insurance is organized centrally, trade unions negotiate inefficiently high wages due to a vertical fiscal externality. The central government generally cannot provide full unemployment insurance as long as migration is costly. In contrast, decentralized unemployment insurance in the member states is efficient irrespective of the degree of mobility and regional asymmetries. Furthermore, efficiency depends on the federal institutions. If the wage bargaining process on the labor markets is decentralized, then decisions about unemployment insurance made at the state level are superior to centralized public insurance. For the efficiency of a centralized unemployment insurance, it matters whether decisions in related institutions like cooperative wage bargaining are also centralized.
unemployment insurance imperfect labor markets federal state union centralization migration vertical fiscal externality