Unemployment insurance has a significant impact on how people''s wages change over time, according to research by Professors Paul Bingley, Lorenzo Cappellari and Niels Westergård-Nielsen. Their analysis of data covering the whole male Danish labour force reveals that there is a marked difference in the wage careers of workers who have joined voluntary insurance schemes compared with those of the uninsured.

Their findings, published in the May 2013 issue of the Economic Journal, suggest that unemployment insurance may reduce workers'' effort and the ''learning-by-doing'' that drives wage growth. The implication is that when workers are insured against unemployment, firms'' wage policies should be flexible and performance-related to counter the disincentive effects of the insurance.

Unemployment insurance and unemployment benefits are generally recognised as key policy complements of reduced employment protection. The Danish ''flexicurity'' system is one of the main examples of such philosophy: firms are free to hire and fire, but an extended social safety net eliminates the risk of poverty and preserves social cohesion. Flexicurity has been advocated in such countries as Italy and Spain as a way of reducing income insecurity and welfare losses associated with labour market reforms.

One peculiarity of the Danish system is that membership of an unemployment insurance is open for anyone to join while in work. Membership is voluntary and organised by trade unions into different funds along occupation and industry lines. The study makes use of changes in individual unemployment insurance membership over time to identify the effects of unemployment insurance on wages.

The difference between the wages of the insured and the uninsured depends on two main factors. First, wage growth is more uniform among insured workers. This means that fast-growing wages grow faster when workers are not insured – by as much as half a percentage point per year relative to the average wage.

Second, the wage career of insured workers is more volatile compared with uninsured workers – that is, insured workers experience more random wage variability from one year to the next compared with uninsured workers. The study estimates the wages of insured workers to be 25% more volatile compared with their uninsured counterparts.

The researchers underline how these findings can be interpreted as symptoms of ''moral hazard'' entailed by unemployment insurance. By lowering the employee costs of being fired, unemployment insurance may reduce workers'' effort and the associated ''learning-by-doing''.

Learning is one of the main drivers of wage growth and the insured would thereby exhibit less wage growth over time. In the end, low effort may result in job loss (particularly in a country with no firing costs), increasing job instability and the volatility of income over time.

An extensive body of previous research indicates that unemployment insurance may reduce the job search efforts of people who are unemployed. This literature generally finds that unemployment benefits may increase unemployment durations. The new study complements this work by investigating for the first time the effects of unemployment insurance on individual wage dynamics.

''Unemployment Insurance, Wage Dynamics and Inequality over the Life Cycle'' by Paul Bingley, Lorenzo Cappellari and Niels Westergård-Nielsen is published in the May 2013 issue of the Economic Journal. Paul Bingley is at SFI – the Danish National Centre for Social Research. Lorenzo Cappellari is at the Università Cattolica Milano. Niels Westergård-Nielsen is at CCP, Aarhus University.

Lorenzo Cappellari

professor of economics at Catholic University of Milan