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Marginal wage subsidies: a rent-extracting instrument for employment creation


  • Andreas Knabe


Purpose - This paper aims to examine the effects of marginal and general wage subsidies on employment and income distribution. Design/methodology/approach - The paper constructs a theoretical, partial-equilibrium model of an economy in which a large number of competitive firms produce a homogeneous output good. Involuntary unemployment arises from a too high and rigid wage. By conducting comparative static analyses, the paper evaluates the impact of general and marginal wage subsidies on employment and incomes. Findings - The paper shows that a marginal wage subsidy is a fiscally more efficient instrument for employment creation than a general wage subsidy because it resembles a combination of a general wage subsidy with a profit tax. These favorable effects persist even if between-firm displacement effects are taken into account. Research limitations/implications - In line with most of the literature on marginal employment subsidies, attention is restricted to a partial-equilibrium analysis in which the wage is assumed to be fixed. This helps to sharpen the focus on between-firm competition, but is perhaps implausible when analyzing a general-equilibrium setting. The inclusion of endogenous wage setting is bound to provide an interesting area for future research. Practical implications - If politicians want to implement a wage subsidy scheme that has to be self-financing, marginal wage subsidies are an effective policy instrument for employment creation. Its downside is an inefficient allocation of labor among firms, because some firms become larger than is necessary. Originality/value - The paper provides a novel approach to model the between-firm displacement effects of marginal wage subsidies and derives policy conclusions.

Suggested Citation

  • Andreas Knabe, 2009. "Marginal wage subsidies: a rent-extracting instrument for employment creation," Journal of Economic Studies, Emerald Group Publishing, vol. 36(4), pages 393-410, September.
  • Handle: RePEc:eme:jespps:v:36:y:2009:i:4:p:393-410

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    Cited by:

    1. Adam, Antonis & Moutos, Thomas, 2011. "A politico-economic analysis of minimum wages and wage subsidies," Economics Letters, Elsevier, vol. 110(3), pages 171-173, March.
    2. Schöb, Ronnie, 2007. "Soziale Grundsicherung und Beschäftigung," Discussion Papers 2007/12, Free University Berlin, School of Business & Economics.
    3. Edward Nissan & Shahdad Naghshpour, 2013. "Connecting corruption to ethnic polarization and religious fractionalization," Journal of Economic Studies, Emerald Group Publishing, vol. 40(6), pages 763 - 774, November.

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    Pay; Unemployment; Subsidies; Labour market;


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