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The Effect of Low-Wage Subsidies on Skills and Employment

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  • Frank Oskamp
  • Dennis J. Snower

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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Bibliographic Info

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
Date of revision:
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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References

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Blog mentions

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  1. Using TARP Moneys to Boost Job Growth - An Impotent Stimulant?
    by Phil Miller in Market Power on 2010-01-28 15:28:38
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Cited by:
  1. Brown, Alessio J G & Merkl, Christian & Snower, Dennis J., 2007. "Comparing the Effectiveness of Employment Subsidies," CEPR Discussion Papers 6334, C.E.P.R. Discussion Papers.
  2. Brown, Alessio J. G. & Koettl, Johannes, 2012. "Active Labor Market Programs: Employment Gain or Fiscal Drain?," IZA Discussion Papers 6880, Institute for the Study of Labor (IZA).
  3. Philip Schuster, 2010. "Labor Market Policy Instruments and the Role of Economic Turbulence," University of St. Gallen Department of Economics working paper series 2010 2010-29, Department of Economics, University of St. Gallen.
  4. Antonio Estache & Elena Ianchovichina & Robert Bacon & Ilhem Salamon, 2013. "Infrastructure and Employment Creation in the Middle East and North Africa," World Bank Publications, The World Bank, number 12237, 5.
  5. 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.
  6. Ianchovichina, Elena & Estache, Antonio & Foucart, Renaud & Garsous, Gregoire & Yepes, Tito, 2012. "Job creation through infrastructure investment in the Middle East and North Africa," Policy Research Working Paper Series 6164, The World Bank.
  7. Dennis Snower & Alessio Brown & Christian Merkl, 2007. "Einstellungsgutscheine effektiver als Kombilöhne," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 60(04), pages 37-41, 02.

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