Optimal Welfare-to-Work Programs

52 Pages Posted: 3 Jan 2007

See all articles by Nicola Pavoni

Nicola Pavoni

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research; Centre for Economic Policy Research (CEPR)

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: November 2006


A Welfare-to-Work (WTW) program is a mix of government expenditures on various labor market policies targeted to the unemployed (e.g., unemployment insurance, job search monitoring, social assistance, wage subsidies). This paper provides a dynamic principal-agent framework suitable for analyzing chief features of an optimal WTW program such as the sequence and duration of the different policies, the dynamic pattern of payments along the unemployment spell, and the emergence of taxes/subsidies upon re-employment. The optimal program endogenously generates an absorbing policy of last resort ("social assistance") characterized by a constant lifetime payment and no active participation by the agent. Human capital depreciation is a necessary condition for policy transitions to be part of an optimal WTW program. The typical sequence of policies is quite simple: the program starts with standard unemployment insurance, then switches into monitored search and, finally, into social assistance. The optimal benefits are decreasing during unemployment insurance and constant during both job search monitoring and social assistance. Whereas taxes (subsidies) can be either increasing or decreasing with duration during unemployment insurance, they must decrease (increase) during a phase of job search monitoring. In a calibration exercise, we use our model to analyze quantitatively the features of the optimal program for the U.S. economy. With respect to the existing U.S. system, the optimal WTW scheme delivers sizeable welfare gains to unskilled workers because the incentives to search for a job can be retained even while delivering more insurance, and using costly monitoring less intensively.

Keywords: Human capital, job search monitoring, recursive contracts, unemployment insurance, welfare-to-work

JEL Classification: D82, H21, J24, J64, J65

Suggested Citation

Pavoni, Nicola and Violante, Giovanni L., Optimal Welfare-to-Work Programs (November 2006). CEPR Discussion Paper No. 5937. Available at SSRN: https://ssrn.com/abstract=954592

Nicola Pavoni

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136

Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

Giovanni L. Violante (Contact Author)

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

United Kingdom

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