(This essay was published in Hong Kong Economic Journal on 16 January 2013)

 

In the US, 8.8 million workers are receiving disability payments from Social Security, according to Professor Edward Glaeser of Harvard University. The number has jumped by 1.7 million from 7.1 million in December 2007. Thirty years ago, there was a 40-to-1 ratio between the total labor force and those workers receiving Social Security disability payments. Today that ratio is less than 18-to-1; it has more than doubled.

 

The large increase in disability payments masks the true employment situation in the US. In 1982, US unemployment hit its postwar high of 10.8%, but disability payments were only 2.5%. But the employment situation is actually worse today even though the unemployment rate is lower. Workers on disability payments currently make up 5.9% of the US labor force, while the unemployment rate is 7.7% – meaning the total share of workers who are either unemployed or receiving disability payments from the government totals 13.6%.  The disabled are among the large number of Americans who have left the labor force altogether since the recession, and who are unlikely to be returning back. All of this does not bode well for US long-term growth.

 

Why have claims for disability risen in the US? Medicine has improved substantially. Fewer workers labor in dangerous industrial jobs. The rate of deaths due to injuries has plummeted. Behavior that can cause disability, such as alcohol use and smoking, has declined substantially. American age-adjusted mortality rates are far lower than in the past. The aging of the baby-boom generation can explain just 15.5% of the growth in disability claims.

 

Two primary alternative hypotheses for the rise in disability claims in the US are that either work has become less attractive or that disability insurance has become more attractive and available. The disability-claims approval process and wider society itself have become more receptive to people claiming disability insurance benefits even if they have no visible ailment.

 

The disability benefit is one of many social entitlement programs at the center of a controversy that has pitted the Democrats against the Republicans over how to balance the fiscal budget and resolve the mounting public debt. Obviously, reforming social entitlements is a huge challenge for the US. Economic recovery and sustained growth depend on the capacity of the economy to create jobs. This depends as much on stimulating business demand as on incentivizing workers to return to the labor force. If social programs provide strong disincentives to work, then the effects of repeated quantitative easing measures would have limited impact.

 

Everyone knows that not working means more time for leisure – a highly desirable activity in itself. An individual will seek to find a proper balance between getting extra income from working longer hours and more time for leisure in pursuit of the best obtainable quality of life. Economists have observed that a person who works fulltime and earns an income of, for example, $1,200 would be glad to accept a sum less than this amount to enjoy more leisure. The amount of income a person is willing to give up in exchange for additional leisure time is the value of the extra leisure.

 

Analytically we can examine two situations. Given there are 168 hours per week and assuming 8 hours a day is spent sleeping, therefore a total of 112 hours is available for allocation between time spent in work and for leisure. In the first scenario an individual works 40 hours per week and is paid the minimum wage of $30 per hour earning $1,200 per week. In the second scenario the individual does not work and earns no income but enjoys 112 hours of leisure time. What “compensation” must this individual receive, say from the government for convenience, in the second scenario in order to make the two scenarios indifferent for him? In the language of economics the objective is to keep his level of satisfaction, happiness or utility in the two scenarios identical.

 

The expected level of benefits provided by many welfare policies should ideally be set with reference to this “compensation” level. For example, the appropriate level of benefits for disability insurance, unemployment compensation, retirement pension, and other welfare benefits should not be set above this “compensation” level. For an individual working 40 hours per week at the minimum wage the “compensation” must obviously be less than $1,200 per week, or otherwise there will be no incentive to work at all.

 

The level of expected benefit is determined by the probability of successful application and the actual level of benefit that is received. For example, the rising share of US workers in the labor force receiving disability insurance benefits is a sign that either the benefit has become too generous or the application success rate has become too high. If that is the case then these should be adjusted.

 

Economists have devised different ways to estimate the appropriate level of this compensation. For simplicity, I assume a specific set of indifference curves of the following form:

 

Utility = α1 x ln(Sleep time) + α2 x ln(Leisure time) + α3 x ln(Work time x Wage rate).

 

I then use this to estimate the appropriate level of compensation that has to be given to a minimum wage worker (earning $30 per hour) to make him indifferent between any scenarios where the number of hours worked per week is not the same.

 

In Table 1 we show the appropriate level of compensation associated with three cases depending on the value of α. Case 1 where α1 = α2 = α3 = 0.33 is the benchmark case. Case 2 where α1 = 0.33, α2 = 0.17, and α3 = 0.50 is the case of an individual who chooses more leisure – the so-called “leisure-lover”. Case 3 where α1 = 0.33, α2 = 0.50, and α3 = 0.17 is the case of an individual who chooses more work – the so-called “work lover”. It is worth noting that those who choose more leisure are those that derive more utility from income enjoyment than the benchmark ones, and vice versa.

 

 

Table 1: Appropriate Compensation Associated with Not Working

 

 

Hours of work per week

20 40 48 56 60 72
Weekly earnings at $30 per hour $600 $1200 $1440 $1680 $1800 $2160
Benchmark case:α2 = α3 = 0.33 Appropriate Compensation $107 $429 $617 $840 $964 $1389
Share of Income 18% 36% 43% 50% 54% 64%
Leisure lover case:α2 = 0.17α3 = 0.50 Appropriate Compensation $74 $313 $460 $640 $744 $1144
Share of Income 12% 26% 32% 38% 41% 52%
Work lover case:α2 = 0.50α3 = 0.17 Appropriate Compensation $190 $671 $919 $1190 $1332 $1778
Share of Income 32% 56% 64% 71% 74% 82%

 

For the benchmark case the appropriate level of compensation for those who work 20 to 72 hours a week varies considerably over the range from $107 to $1,389 a week. The amount rises with hours of work in a non-linear manner. At low hours of work, say 20 hours per week, the amount is only 18% of income, but doubles to 36% at 40 hours per week, and reaches 64% at 72 hours per week.

 

The leisure-lover in general has a lower level of appropriate compensation that ranges from $74 to $1,144; which is from 12% to 52% of income. For the work-lover, the appropriate level of compensation is higher and the amount range from $190 to $1,778, which is from 32% to 82%.

 

If given a compensation of $700 a week an individual working less than 56 hours a week at the minimum wage of $30 per hour would probably be willing to voluntarily withdraw from the labor force altogether to take up fulltime leisure activities.

 

Another interesting implication of the above analysis is the recently approved means tested Old Age Living Allowance of $2200 a month (approximately $500 per week). This amount would be equivalent compensation for a minimum wage employee working around 40 hours per week. A retired individual would deem this level of allowance as good as working full time. For low wage employees this is getting very close to the limit where the allowance generates disincentives for work to prefer retirement instead.

 

At present, single able-bodied elderly persons and adults suffering from ill-health or who are 50% disabled, are eligible to receive support under the Comprehensive Social Security Assistance (CSSA) scheme which pays them the standard rate of $2820 per month. This amount is close to the level of compensation of $700 a week where an individual would prefer to voluntarily withdraw from the labor force. One would surmise that the CSSA scheme is certainly not mean at all and may be considered generous using the numbers derived from the simulations reported in Table 1.

 

Hong Kong workers work for long hours in the labor force. Chart 1 presents a histogram of the number of hours worked in a week for men and women earning the minimum wage in Hong Kong. Most individuals have work hours clustering around 48, 60 and 72 hours per week. The number of workers centered on these three clusters is about the same. Obviously workers in Hong Kong have a strong incentive to work. Average incomes in Hong Kong are comparable to the more advanced economies in the world. So what explains the strong incentive to work?

 

I think low tax rates are an important consideration. Many low-income individuals are outside the coverage of the tax net. This provides a stronger incentive for them to stay employed and work long hours. This is unfortunately not the case in the US and many other advanced economies, where generous welfare benefits supported by high taxes have worked to create a powerful dual incentive for withdrawing from the labor force.

 

For those individuals who are inclined to work fewer than 48 hours per week the CSSA benefit in Hong Kong is likely to be too generous already and is a clear disincentive to joining the labor force; a situation that might be similar to that in the US.

 

The relatively recent emergence of the “houseman” or “otaku” (宅男) in the last decade can be explained by this simple analysis. These are young men who have chosen to stay at home without going to work. There are two reasons for this: first, their time spent at home has been partly subsidized by CSSA payments, and second, keeping them entertained at home has become easier with the invention of the Internet.

 

The wage rates of these young men are probably low so the minimum wage assumption could be applied to them. They would probably have chosen to work less than 48 hours a week to begin with, perhaps even as low as 20 hours a week. One can think of them as belonging to the class of “leisure lovers”. Some of those who qualify for the CSSA scheme would have a strong incentive to drop out of the labor force altogether.

 

Like the US, Hong Kong gradually expanded its various social entitlement programs in the 1960s. The CSSA scheme is one of those programs. Research studies on the disincentive effects of generous welfare programs are few and should be undertaken. Today society is poised to expand these programs further amidst concerns of rising poverty and a widening income and wealth gap. This should be undertaken with caution to avoid creating even stronger incentives for individuals, especially young workers, to withdraw from the labor force.

 

Tyler Cowen has observed that, “The Internet has not changed everyone’s life, but it has changed a lot of lives. The product produced by [the] Internet is interior to the human mind rather than on a factory floor. We use Twitter, Facebook, MySpace, and other Web services to construct a complex meld of stories, images, and feelings in our minds. These innovative activities do not generate much revenue for the economy; they only produce happiness and personal growth.” Perhaps getting away from the fascination with material wealth of the old generation is not a bad thing, but combining the effects of the Internet with the CSSA scheme can really hurt the economy badly.

 

References:

 

Edward Glaeser, “2013 Is the Year to Go to Work, Not Go on Disability”, Bloomberg View, 27 December 2012. http://www.bloomberg.com/news/2012-12-27/2013-is-the-year-to-go-to-work-not-go-on-disability.html

 

Tyler Cowen, The Great Stagnation: How America Ate All the Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better, Dutton, 2011.

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