TEMPORARY DISABILITY INSURANCE: Evidence from Norway of the impact of benefit levels on labour supply

The duration and outcome of spells on temporary disability insurance (TDI) depend critically on the claimants'' economic incentives as well as on local labour demand conditions. That is the central finding of research by Elisabeth Fevang, Inés Hardoy and Knut Røed, published in the August 2017 issue of the Economic Journal.

Their study finds that the labour supply of claimants responds significantly to variations in the benefit level. The point estimates imply, for example, that a 10% cut in the benefit level would induce approximately a 3.3% increase in the transition rate to regular employment, a 2.5% increase in the transition rate to permanent disability and a 3.9% increase in the transition rate to regular unemployment.

The researchers also find that the transition rate from temporary disability to employment is sensitive to labour market conditions. An increase in local labour demand corresponding to a 10% increase in the transition intensity from unemployment to employment yields approximately a 1.9% increase in the transition intensity from TDI to employment.

The study starts from the observation that the caseloads of disability insurance programmes have risen considerably in many countries, and that this represents a major challenge for long-term fiscal sustainability. It is therefore important to understand the mechanisms behind the use of temporary disability insurance – and how benefit levels and labour market conditions affect the outcome of insurance spells.

The authors note that it has been difficult to identify and estimate the causal impacts of such conditions, since they rarely exhibit any random assignment components. Hence, if we observe that, say, people with high benefits tend to spend more time on TDI, it is difficult to say whether this reflects causality or just that people with high benefits also tend to be people with particularly poor health or poor labour market prospects.

This is where the new study comes in. Based on a reform of the Norwegian TDI system in 2002, which changed benefit levels differently for different claimants in an arguably random assignment-like fashion, the authors estimate causal impacts of the TDI benefit level on the duration and outcome of TDI spells.

It is notable that the estimated labour supply responses that they find are roughly half as large as those previously estimated for unemployed jobseekers in Norway. This suggests that individuals who are temporarily disabled do indeed face a more restricted labour market choice set than the registered unemployed. Given that the people included in the analysis are deemed to be seriously disabled, the authors nevertheless consider the identified responses to be substantial.

Taken together, the results support the view that there is a significant labour supply potential among temporarily disabled people, and that the realisation of this potential can be encouraged to some extent by means of financial incentives.

Although this probably implies that there is an efficiency loss associated with the relatively generous TDI benefit level in Norway (with replacement rates around 66%) – in terms of too low transition rates to regular employment – it does not necessarily follow that a lower benefit level is the desired policy from a welfare perspective.

Generous TDI benefits protect those who are unable to find substantially gainful employment, as well as their dependents, from poverty. In the presence of liquidity constraints, it also provides claimants who ultimately have the capacity to return to the labour market with more time in which to find a suitable and viable job match.

''Temporary Disability and Economic Incentives'' by Elisabeth Fevang, Inés Hardoy and Knut Røed is published in the August 2017 issue of the Economic Journal. Elisabeth Fevang and Knut Røed are at the Ragnar Frisch Centre for Economic Research in Oslo. Inés Hardoy is at the Institute for Social Research in Oslo.