ChainWhat it assumes · how to break it
Start
The government raises out-of-work benefits, for example the standard allowance of Universal Credit, while pay in low-wage jobs rises more slowly.
1
As a result, the income a person receives when not working rises relative to the income they would earn in a job, so the replacement ratio rises.
replacement ratio
replacement ratio
Assumes: Wages in low-paid jobs do not rise by as much.
But: If the National Living Wage rises at the same time, the gap between income in and out of work can be maintained.
2
This means the financial gain from taking a job or working more hours is smaller, especially as Universal Credit is withdrawn at a set rate for each extra pound earned.
benefit trap · effective marginal tax rate
benefit trap · effective marginal tax rate
Best link to attack
Assumes: People decide whether to work mainly on financial gain.
Assumes: People decide whether to work mainly on financial gain.
But: Many people value work for status, routine and career progression, and Universal Credit sets job search conditions with sanctions for claimants who do not meet them.
3
Consequently, some claimants delay taking low-paid jobs and some part-time workers choose not to increase their hours, so the supply of labour falls.
supply of labour · work incentives
supply of labour · work incentives
Assumes: Low-paid workers can choose their hours.
But: Many low-paid workers have hours set by their employer, so they have little scope to cut or add hours in response to the benefit system.
4
Therefore, voluntary unemployment rises and the employment rate is lower than it would otherwise be.
voluntary unemployment · employment rate
voluntary unemployment · employment rate
Assumes: Jobs are available for those who choose to look.
But: In a recession, unemployment is mainly demand-deficient, so benefit levels are not what keeps most people out of work.
End
Work incentives weaken, voluntary unemployment rises and employment is lower than it would otherwise be.
Evaluation chain
- E1However, the fall in employment depends on how strongly claimants respond to the financial gain from working.
- E2Because Universal Credit attaches job search requirements and sanctions to out-of-work support, many claimants must look for work whatever the replacement ratio.
- E3As a result, the fall in labour supply from a higher benefit is limited, and non-financial reasons for working keep many people in jobs.
- E4So higher benefits reduce employment by much less than a simple incentive model predicts, and the effect is largest only where the gain from work is very small.
Another way to attack it: Higher benefits also raise AD because recipients have a high MPC, which raises the derived demand for labour. In a downturn this demand effect can outweigh the incentive effect, so total employment may rise.
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Questions this answers
- Assess the view that higher welfare benefits increase unemployment.
- Discuss the trade-off between reducing poverty and keeping incentives to work.
- Explain how the withdrawal of benefits as earnings rise can create a poverty trap.
Diagram
No standard diagram. A simple table comparing a claimant's net income in and out of work shows the replacement ratio and the effect of the taper clearly.
Reverse and related
Benefit cut or freeze → replacement ratio falls → stronger incentive to work, but deeper poverty for those who cannot find a job.