Wednesday, 5 August 2009

The impact of wage subsidies

An interesting post from Economic Logic on The impact of wage subsidies
Several European countries, including Germany, have wage subsidies to encourage employer to hire unemployed workers. While there is no doubt that, at the margin, this can reduce unemployment, the real question is whether those hired with a subsidy also stay employed after the subsidy expires, and have longer employment spells than those hired without a subsidy.

Gesine Stephan looks at the German case and finds the subsidy works in the sense that after 3.5 years the cumulated wages are higher for the subsidized workers. But does it work well enough to justify the cost of the subsidy. On average, the subsidy amounts to €2500 to €3000. This results in cumulative wages increased by €2200 to €5000. Is this worthwhile? First, this generates more tax and social security income, second, less needs to be spent on unemployment insurance. In a carefully worded appendix, Stephan argues it looks like wages subsidies are fiscally beneficial at least to a first approximation. While this result is subject to all sorts of qualification, I am glad that, for once, a cost-benefit analysis of a policy is performed, instead of only showing that something is statistically significant.
One question I would ask is, Given that the subsidy has to be funded out of taxation, does the study take into account the full effects of raising the necessary taxation? After all if you didn't have the subsidy and reduced the tax take by the amount of the subsidy the money would get spent or invested which would also increase employment. Thus does having the subsidy really raise employment more than not having it?

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