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The Effect of Low-Wage Subsidies on Skills and Employment

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Author Info
Frank Oskamp
Dennis J. Snower

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Abstract

We explore the far-reaching implications of low-wage subsidies on skill formation, aggregate employment and welfare. Low-wage subsidies have three important effects. First, they promote employment of low-skilled workers (who tend to be the ones who earn low wages). Second, by raising the payoff of low-skilled work relative to skilled work, low-wage subsidies reduce the incentive to become skilled. So they increase the low-skilled labor force which faces a relatively low employment rate. Third, the government budget constraint has to be taken into account, which is supposed to cause an additional tax burden for the skilled workers. This amplifies the negative effect of low-wage subsidies on the incentive to acquire human capital. Thus, the first effect on the one hand and the second and third effect on the other hand pull in opposite directions in terms of employment. This paper presents a theoretical model of the labor market in which these effects can be analyzed. We then calibrate the model with respect to the German labor market to shed light on the relative strengths of these effects and thereby assess the degree to which low-wage subsidies encourage or discourage employment. The calibration shows that low-wage subsidies have a negligible effect on aggregate employment. Although they do stimulate low-skilled employment, they also reduce medium-skilled employment, and the net effect is very small.

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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1292.

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Length: 25 pages
Date of creation: Sep 2006
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Handle: RePEc:kie:kieliw:1292

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Related research
Keywords: low-wage subsidies; training incentives; employment; unemployment; skill acquisition;

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Find related papers by JEL classification:
I29 - Health, Education, and Welfare - - Education - - - Other
J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure
J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
J38 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Public Policy

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References listed on IDEAS
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    Other versions:
  2. Alexander Spermann & Harald Strotmann, 2006. "The Targeted Negative Income Tax (TNIT) in Germany: Evidence from a Quasi Experiment," IZA Discussion Papers 2067, Institute for the Study of Labor (IZA). [Downloadable!]
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  6. James Heckman & Lance Lochner & Ricardo Cossa, 2002. "Learning-By-Doing Vs. On-the-Job Training: Using Variation Induced by the EITC to Distinguish Between Models of Skill Formation," NBER Working Papers 9083, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  13. Regina Riphahn & Anja Thalmaier & Klaus F. Zimmermann, 1999. "Schaffung von Arbeitsplätzen für Geringqualifizierte," IZA Research Reports 2, Institute for the Study of Labor (IZA). [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Pascal Belan & Martine Carré & Stéphane Gregoir, 2007. "Subsidizing low-skilled jobs in a dual labor market," THEMA Working Papers 2007-17, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise. [Downloadable!]
  2. Alessio J. G. Brown & Christian Merkl & Dennis J. Snower, 2007. "Comparing the Effectiveness of Employment Subsidies," IZA Discussion Papers 2835, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
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