Unemployment Insurance: A General Equilibrium Model for the Chilean Economy

Acknowledging that a non-zero level of benefits is socially optimal, and may even be considered efficient, this paper implements a labor search model that distinguishes between unemployed with and without benefits to quantify the effects on the Chilean labor market that result from increasing unemployment benefits as well as the pool of potential beneficiaries. Simulations show that both policies result in higher average unemployment, longer mean unemployment duration (MUD) and a tighter labor market, although having a larger mass of eligible workers has on average a lower impact than increasing the replacement rate. Because we do not measure possible efficiency gains nor the effects of having these benefits being financed in part by the own worker's savings, elements that may ameliorate the negative effects of the policy changes, the magnitudes discussed should be considered as upper bounds. Simulations show that mean unemployment increases 0.1 percent points when either average benefits increase by 8.3 percent points (from an initial level of 30%) or the proportion of eligible workers increases by 10 percent points (from 45 to 55% of the labor force). MUD in turn increases approximately 1% and the measure of market tightness by 4%. The effects on these three measures are similar when we either assume that workers’ bargaining power is lower or that the separation rate is higher. Nevertheless, when workers are assumed to have other sources of non-labor income, the impact of both policies is more pronounced..