Optimal Workfare with Voluntary and Involuntary Unemployment*

This paper addresses the welfare implications of introducing workfare into unemployment benefit policy. We consider a population composed of employed and unemployed workers and of individuals who do not seek employment. Job search behavior is unobservable, which means that voluntarily unemployed individuals can claim unemployment insurance (UI) benefits intended for unemployed workers. As a consequence, pecuniary benefit schemes underinsure workers against unemployment. We show that requiring unproductive activities (workfare) in exchange for UI benefits may generate a Pareto improvement by facilitating better unemployment insurance for workers, and we characterize the situations where this is the case.