Job subsidies are a step in the wrong direction

 

ECONOMICS:With GDP declining at a rapid pace, there simply is no magic wand that politicians can wave, writes KARL WHELAN

THE IMPACT of the current economic downturn has been felt all across Irish society, but there is little doubt that those most affected are the thousands of workers newly afflicted with unemployment.

Many of these people are now dealing with the stress of coping with financial commitments that probably seemed prudent when made during our long economic expansion. For those of us who remember the period before the Celtic Tiger, the looming spectre of mass long-term unemployment is a truly depressing one.

Against this background, it is understandable that the Government is facing increasingly loud calls from Opposition politicians, unions and business interests to do something to limit unemployment. In particular, a number of tax subsidy schemes have been suggested.

One such proposal is Fine Gael’s plan to give firms hiring unemployed workers either a direct subsidy or a waiver on employer PRSI. Another is call from the Irish Small and Medium-Sized Enterprise Association for an employment subvention fund to protect existing jobs.

Without doubt, these proposals are well intentioned. However, it is my opinion that it would be a mistake for the Government to adopt these schemes.

The ultimate source of the current high level of unemployment is the weak demand for workers because of the sharp decline in economic output. With GDP declining at a rapid pace, there simply is no magic wand that politicians can wave to prevent a steep reduction in the demand for workers.

Policies aimed at offsetting this reduction in demand using wage subsidies are unlikely to have more than a marginal effect. Research has generally shown that the demand for workers from firms is not very responsive to wage rates, so even schemes that offer generous temporary tax incentives are only likely to have a minimal effect on the overall level of employment.

Despite their limited effectiveness, employment subsidy schemes can be very expensive for the taxpayer. The proposals suffer from what economists call “deadweight loss” – most of the money will go to firms that will not create any new jobs as a result of the policies.

As an example, consider the provision of subsidies to protect existing jobs. In practice, it will simply not be possible for a Government agency to identify those firms that would be laying off workers without the subsidy and those that would not.

If introduced, the subsidy would most likely be given to many firms that would end up with the same number of workers they would have had without the scheme. Furthermore, to the extent that some of the failing businesses that would receive such support simply may not be viable over the next few years, these schemes can end up pouring money into firms whose workers still end up losing their jobs.

The deadweight loss problem also applies to policies to subsidise firms that are increasing employment. It is tempting to view recessions as periods when “firms are cutting jobs” and booms as periods when “firms are increasing jobs”, but the reality is more complex. Research has actually shown that, at all points in time, there are firms increasing employment while other firms are cutting employment.

For example, even at the height of the Celtic Tiger boom in 2000, our overall employment growth of 8 per cent was driven by expanding firms contributing a positive 15 percentage points and contracting firms contributing a negative seven percentage points.

Conversely, even during terrible years such as 1983, when employment fell by 5 per cent, expanding firms still contributed a positive eight percentage points.

Judging then from the research available to us, it is likely that, even in the middle of a severe recession, expanding firms will still probably contribute at least a positive 5 per cent to employment growth over the next few years. With something like 1.6 million people employed in the private sector, the implied deadweight annual cost to the taxpayer of a €6,000 subsidy for each additional worker hired would work out at about €500 million per year.

At times of economic crisis, it is easy to blame politicians for everything and equally easy for us to look to them to provide instant solutions. In truth, however (and despite electoral promises that suggest the contrary), governments have only the most indirect control over the future of the economy. In general, the best thing governments can do to induce economic growth, and thus increase employment, is to provide a stable economic environment that encourages long-term sustainable investments by businesses. In our current position, this means solving our fiscal problems by controlling Government spending and raising tax revenues by broadening our tax base rather than raising tax rates to punitive levels.

Measures like job subsidies, which erode the tax base and provide little “bang for the buck”, are a step in the wrong direction.

That said, there is a strong case to be made for certain well-targeted labour market expenditures, aimed for instance at keeping the long-term unemployed engaged in the labour market. Such schemes, if implemented well, can help to limit the human suffering associated with long-term unemployment and may also pay for themselves if they can limit the longer-term effects on unemployment of the current recession.

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