1.3 Million People Lost Unemployment Benefits. It Could Get Ugly

When Congress reconvenes on Jan. 6, one of the first issues it will take up is whether to renew an emergency federal unemployment program that expired on Dec. 28, cutting off 1.3 million jobless workers. Enacted in 2008 at the start of the recession, it provided up to 47 weeks of benefits for those still looking for work when their state unemployment benefits ran out. Senate Majority Leader Harry Reid says he’ll try to pass a temporary extension, but most Republicans have balked at the $25 billion-a-year cost. If the program isn’t revived, the impact could be significant—not just for the 1.3 million people losing a vital lifeline but on the broader economy.

How will these workers fare? One place to look for answers is North Carolina. Last February, at the behest of the business community, Republican Governor Pat McCrory signed a bill cutting the amount and duration of state jobless benefits, even though North Carolina’s unemployment rate ranked among the highest in the country. The state had exhausted its unemployment trust fund, paid for by business taxes, and had borrowed $2.5 billion from the federal government to pay jobless claims. “We’re going to pay down that debt, make the system solvent, and provide an economic climate that allows businesses, large and small, to put people back to work,” McCrory said at the time. When the new law took effect on July 1, the maximum weekly benefit fell from $535 to $350 and its duration fell to between 12 and 20 weeks (depending on the state’s unemployment rate) from 26 weeks—the standard in most other states.

That was only half the blow. Reducing state benefits violated the terms of the federal program—which is intended to supplement, not replace, state aid—so workers in North Carolina were also disqualified from receiving federal benefits. In essence, the state’s experience over the last six months is a harbinger of what may be in store for the rest of the country. “This doesn’t have to be a thought experiment, because you can just look at what’s happened in North Carolina,” says Aaron Chatterji, an economist at Duke University’s Fuqua School of Business. “The 1.3 million people losing their benefits are going to be in the same position as the 170,000 people here who have lost theirs.”

At first glance, the effect appears to be positive. North Carolina’s unemployment rate dropped dramatically, from 8.8 percent to 7.4 percent between July and November. By comparison, the national unemployment rate fell by 0.6 percent over the same period. A closer look, however, suggests that North Carolina’s unemployment numbers have fallen not because the long-term jobless have found work but because they’ve quit looking altogether. As a result, the state no longer counts them as unemployed.

“The decline in the unemployment rate gives you a very limited view of what’s going on in our labor market,” says John Quinterno, founder of South by North Strategies, an economic research firm in Chapel Hill, N.C. “Year over year, the number of employed people in North Carolina ticked up by 6,082, while the unemployed fell by 101,901. That means the labor force contracted by 95,009. So the improvement has not necessarily been driven by more people going to work and is actually being driven to a large degree by people leaving the labor force.” In October the state’s labor force participation rate hit a 37-year low. One benefit of unemployment insurance is that “it has an anchoring effect,” says Quinterno, “because you have to be looking for work” to qualify for benefits.

Though the job market hasn’t fully recovered from the recession, many Republicans believe extending jobless benefits saps workers’ motivation to seek employment or accept positions they deem less than ideal. “I do support unemployment benefits for the 26 weeks that they’re paid for,” Kentucky Senator Rand Paul said on Fox News on Dec. 8. “Beyond that, you do a disservice to these workers. When you allow people to be on unemployment insurance for 99 weeks, you’re causing them to become part of this perpetual unemployed group.”

Economic research has shown that some job seekers do become less selective about the jobs they’re willing to take once their unemployment insurance expires—the so-called “employment effect.” There’s evidence this may be occurring in North Carolina. A Dec. 20 note from JPMorgan Chase’s (JPM) chief U.S. economist, Michael Feroli, pointed out that the state’s employment growth has outpaced national growth since July. Yet he also noted that labor force participation has fallen much faster than it has nationally. “In this case,” he concluded, “it would appear both channels are operative but the participation effect may be more important.”

It’s hard to draw firm conclusions from limited data. But if the expiration of jobless benefits is prompting large numbers of North Carolinians to give up looking for work, it would augur poorly for the state’s economy and the country’s, too. Working-age Americans who can’t find gainful employment represent lost economic value and unmet U.S. growth potential. While some may settle for part-time work, others will try to qualify for disability. Long stretches of unemployment reduce the likelihood of finding a job, as skills and connections atrophy.

As people cycle in and out of the unemployment system this year, an additional 3.6 million workers will lose access to benefits if federal insurance isn’t restored, according to a December report by the White House Council of Economic Advisers. That’s a lot of misery and squandered economic potential. It’s also why “the Tar Heel test tube,” as Feroli has dubbed it, is worth paying attention to. Says Chatterji, “The statistics are so dramatic.”