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Capital Subsidies versus Labor Subsidies: A Trade-Off between Capital and Employment?

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  • Petrucci, Alberto
  • Phelps, Edmund S

Abstract

This paper examines the effects of factor subsidies on capital formation and employment in an OLG small open economy model of wealth accumulation. Two cases are explored, one with neoclassical wages and one with incentive-wages. We show that in the neoclassical model a capital subsidy spurs capital and causes a temporary increase in manhours which vanishes in the long-run, while a labor subsidy may temporarily increase inputs, but is neutral for steady state capital and labor. In the incentive-wage economy, a capital subsidy boosts investment and aggravates unemployment, while a labor subsidy stimulates employment and will in some conditions depress capital formation.

Suggested Citation

  • Petrucci, Alberto & Phelps, Edmund S, 2005. "Capital Subsidies versus Labor Subsidies: A Trade-Off between Capital and Employment?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 907-922, October.
    • Handle: RePEc:mcb:jmoncb:v:37:y:2005:i:5:p:907-22
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    Cited by:

    1. Petrucci, Alberto & Phelps, Edmund S., 2009. "Two-sector perspectives on the effects of payroll tax cuts and their financing," Journal of Public Economics, Elsevier, vol. 93(1-2), pages 176-190, February.
    2. Bijie Ren, 2008. "The regional effects of marginal wage subsidies," Psychometrika, Springer;The Psychometric Society, vol. 3(4), pages 598-626, December.
    3. Petrucci, Alberto, 2006. "Wealth Accumulation and Growth in a Specific-Factors Model of Trade and Finance," Economics & Statistics Discussion Papers esdp06029, University of Molise, Department of Economics.

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