This paper explores the consequences of lower disability benefits on the number of people in disability schemes and unemployment schemes. In particular, a principal agent model is developed in which a control agency assigns either disability benefits or unemployment benefits to jobless workers. As the control agency (the agent) takes the interest of both the government (the principal) and the worker into account, there is a possibility of improper use of disability schemes by so-called hidden unemployed. The model is estimated in error correction form by using Dutch data. We find that approximately 50 percent of disability benefits in The Netherlands is due to improper use. The partial framework is linked to an applied general equilibrium model for the Dutch economy, labeled MIMIC. Accordingly, we are able to explore the effects of lower social benefit levels on official and hidden unemployment. More specifically, lower benefit levels may exert, first, a substitution effect between unemployment schemes and disability schemes and, second, a scale effect on total unemployment through several general equilibrium mechanisms. Simulations suggest that reducing disability benefits by 5 percentage points while maintaining unemployment benefits will reduce total unemployment by 0.7 percent. Almost half of this reduction is due to lower hidden unemployment. Reducing unemployment benefits by 5 percentage points while keeping disability schemes unaffected, raises hidden unemployment slightly while reducing total unemployment by 0.8 percent.

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Journal of Policy Modeling
Erasmus School of Economics

de Mooij, R. (1999). Disability Benefits and Hidden Unemployment in The Netherlands. Journal of Policy Modeling, 695–713. doi:10.1016/S0161-8938(97)00103-8