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Labor Market Policy Instruments and the Role of Economic Turbulence

  • Philip Schuster

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    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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    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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    1. Den Haan, Wouter & Haefke, Christian & Ramey, Gary, 2004. "Turbulence and Unemployment in a Job Matching Model," CEPR Discussion Papers 4765, C.E.P.R. Discussion Papers.
    2. Gabriele Cardullo & Bruno Van der Linden, 2007. "Employment Subsidies and Substitutable Skills: An Equilibrium Matching Approach," Applied Economics Quarterly (formerly: Konjunkturpolitik), Duncker & Humblot, Berlin, vol. 53(4), pages 375-404.
    3. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
    4. Blanchard, Olivier J & Tirole, Jean, 2007. "The Joint Design of Unemployment Insurance and Employment Protection. A First Pass," CEPR Discussion Papers 6127, C.E.P.R. Discussion Papers.
    5. Pierre Cahuc & Thomas Le Barbanchon, 2009. "Labor Market Policy Evaluation in Equilibrium: Some Lessons of the Job Search and Matching Model," Working Papers hal-00396295, HAL.
    6. Burda, Michael C. & Mertens, Antje, 2001. "Estimating wage losses of displaced workers in Germany," Labour Economics, Elsevier, vol. 8(1), pages 15-41, January.
    7. James S. Costain & Michael Reiter, 2003. "Business cycles, unemployment insurance and the calibration of matching models," Economics Working Papers 872, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2006.
    8. Burda, Michael C & Wyplosz, Charles, 1993. "Gross Worker and Job Flows in Europe," CEPR Discussion Papers 868, C.E.P.R. Discussion Papers.
    9. Brown, Alessio J.G. & Merkl, Christian & Snower, Dennis J., 2011. "Comparing the effectiveness of employment subsidies," Labour Economics, Elsevier, vol. 18(2), pages 168-179, April.
    10. Ammermüller, Andreas & Zwick, Thomas & Boockmann, Bernhard & Maier, Michael, 2007. "Do hiring subsidies reduce unemployment among the elderly? Evidence from two natural experiments," ZEW Discussion Papers 07-001, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    11. 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.
    12. Robert E. Hall, 2005. "The Amplification of Unemployment Fluctuations through Self-Selection," NBER Working Papers 11186, National Bureau of Economic Research, Inc.
    13. Bruce C. Fallick, 1995. "A review of the recent empirical literature on displaced workers," Finance and Economics Discussion Series 95-14, Board of Governors of the Federal Reserve System (U.S.).
    14. Robert Shimer, 2005. "The Cyclical Behavior of Equilibrium Unemployment and Vacancies," American Economic Review, American Economic Association, vol. 95(1), pages 25-49, March.
    15. Lazear, Edward P, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 699-726, August.
    16. 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.
    17. Bonin, Holger & Kempe, Wolfram & Schneider, Hilmar, 2002. "Household Labor Supply Effects of Low-Wage Subsidies in Germany," IZA Discussion Papers 637, Institute for the Study of Labor (IZA).
    18. Jean-Baptiste Michau, 2012. "Optimal labor market policy with search frictions and risk-averse workers," Working Papers hal-00757173, HAL.
    19. Frank Oskamp & Dennis J. Snower, 2006. "The Effect of Low-Wage Subsidies on Skills and Employment," Kiel Working Papers 1292, Kiel Institute for the World Economy.
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