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Labor Market Policy Instruments and the Role of Economic Turbulence

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  • Philip Schuster

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    Abstract

    Times of high unemployment always inspire debates on the role of labor market policy and its optimal implementation. This paper uses a dynamic model of search unemployment and bilateral wage bargaining to characterize optimal labor market policy in a possibly turbulent environment. A firing externality, generated by the existence of a partial unemployment insurance system, distorts the pre-policy equilibrium along three margins: job creation, job acceptance, and job destruction. Optimal policy is characterized by a payroll tax, a firing tax, and a hiring subsidy. Endogenous job acceptance demands that a firing tax and a hiring subsidy have to be set equal in any case and cannot be used to correct for the possible failure of the Hosios condition. In that case the optimal policy mix has to be extended by either an output or recruitment tax/subsidy. It is further shown that the derived policy mix is robust to the introduction of economic turbulence in form of state-dependent worker transitions between skill classes. This is crucial as widely discussed intergroup redistribution schemes, like in-work benefits targeted at low-skilled workers, are rendered considerably less effective in that case. Instead of redistribution from high- to low-skilled workers or from firing firms to unemployed workers, the paper identifies a scheme involving redistribution from firing to hiring firms to be optimal.

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    File URL: http://www1.vwa.unisg.ch/RePEc/usg/dp2010/DP-1029-Schu.pdf
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    Bibliographic Info

    Paper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2010 with number 2010-29.

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    Length: 41 pages
    Date of creation: Oct 2010
    Date of revision:
    Handle: RePEc:usg:dp2010:2010-29

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    Related research

    Keywords: Search and matching; employment subsidies; economic turbulence; policy spill-over;

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    1. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 397-415, July.
    2. Cardullo, Gabriele & Van der Linden, Bruno, 2006. "Employment Subsidies and Substitutable Skills: An Equilibrium Matching Approach," IZA Discussion Papers 2073, Institute for the Study of Labor (IZA).
    3. Wouter J. Den Haan & Christian Haefke & Garey Ramey, 2004. "Turbulence and unemployment in a job matching model," Economics Working Papers 792, Department of Economics and Business, Universitat Pompeu Fabra.
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    13. Lazear, Edward P, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 699-726, August.
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    15. Hans-Werner Sinn & Christian Holzner & Wolfgang Meister & Wolfgang Ochel & Martin Werding, 2006. "Aktivierende Sozialhilfe 2006 - das Kombilohn-Modell des ifo Instituts," Ifo Schnelldienst, Ifo Institute for Economic Research at the University of Munich, vol. 59(02), pages 06-27, 01.
    16. Burda, Michael & Wyplosz, Charles, 1994. "Gross worker and job flows in Europe," European Economic Review, Elsevier, vol. 38(6), pages 1287-1315, June.
    17. Robert E. Hall, 2005. "The Amplification of Unemployment Fluctuations through Self-Selection," NBER Working Papers 11186, National Bureau of Economic Research, Inc.
    18. Pissarides, Christopher A, 1992. "Loss of Skill during Unemployment and the Persistence of Employment Shocks," The Quarterly Journal of Economics, MIT Press, vol. 107(4), pages 1371-91, November.
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