Extended Unemployment Benefits and Early Retirement: Program Complementarity and Program Substitution

This paper explores how extended unemployment insurance (UI) benefits targeted to older workers affect early retirement and social welfare. We argue that the analysis of UI's tradeoff between consumption smoothing and moral hazard needs to consider the entire early retirement system, which often consists of extended UI and relaxed access to disability insurance (DI). We argue that extended UI generates program complementarity (higher future take-up of DI and/or regular retirement benefits) or program substitution (lower contemporaneous take-up of DI benefits). Exploiting Austria's regional extended benefit program, which extended regular UI benefits to up to 4 years, we find: (i) program complementarity is quantitatively important for workers aged 50+; and (ii) program substitution is quantitatively relevant for workers aged 55+. We derive an optimal UI formula in the spirit of Baily (1978) and Chetty (2006) that features program complementarity and program substitution. Using the sufficient statistics approach, we conclude that UI for older workers was too generous and the regional extended benefit program was a suboptimal policy.