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Subsidies that save

Edmund S PhelpsEdmund Phelps is Professor of Economics at Columbia University and Director of its Center on Capitalism and Society.

by Edmund S Phelps

Was France’s recent wave of protests against an amendment that would have increased employers’ freedom to fire young workers a blessing in disguise? To defuse the protests, President Jacques Chirac was forced to withdraw the provision, and instead has proposed hiring subsidies as a way to reduce youth joblessness. A related proposal for targeted wage subsidies is being floated in Germany.

Advocates of greater labor-market flexibility insist that paying employers to hire young people is the wrong approach. Allow employers to fire workers more easily, they argue, and employers will hire them more readily. The limitation of this approach, however, is that a free market for labor will neither eradicate unemployment nor transform marginal, low-end workers into high-productivity, high-wage employees. If the proposed subsidies in France and Germany have a defect, it is not that they are unnecessary, but that they do not go far enough.

In the advanced economies of the West, many people in all age groups are effectively left out of formal employment. In the United States, the pay of less qualified workers is so meager that, if their situation is not dire, they find it emotionally difficult to keep a job for long, or they become too demoralised or distracted to be adequate employees, or minimum-wage laws make them unaffordable to law-abiding employers. In Europe, they are excluded from employment by labor agreements and in some cases by minimum-wage laws. In both cases, these workers lose the opportunity for engagement and personal development that most legitimate jobs provide.

This deprivation in turn generates high social costs, including crime, violence, and dependency. The latter pathologies then become a weapon in the populist attack on free enterprise, which Western countries require for economic dynamism – and thus prosperity. So those who are included and benefit by free enterprise, yet are burdened by the social costs of exclusion, should all be willing to pay something to remedy these conditions.

The best remedy is a subsidy for low-wage employment, paid to employers for every full-time low-wage worker they hire and calibrated to the employee’s wage cost to the firm. The higher the wage cost, the lower the subsidy, until it has tapered off to zero. With such wage subsidies, competitive forces would cause employers to hire more workers, and the resulting fall in unemployment would cause most of the subsidy to be paid out as direct or indirect labor compensation. People could benefit from the subsidy only by engaging in productive work – that is, a job that employers deem worth paying something for.

Ideally, the subsidies will go for employing workers of all ages. However, it is understandable that plans under current discussion envision focusing first on the youngest and oldest workers.

Some people still think of wage subsidies as a welfare hand-out. But these subsidies are very different from social assistance and social insurance programs. Although such programs have been substantial in Europe and the US, the working poor remain as marginalised as ever. Indeed, social spending has worsened the problem, because it reduces work incentives and thus creates a culture of dependency and alienation from the commercial economy, undermining labor force participation, employability, and employee loyalty. What is needed is higher employment and pay through higher demand for the least productive workers.

Some would count on the free market to solve the problem with time. But market forces alone are unlikely to solve the unprecedented levels of labor-market exclusion that developed from the mid-1970’s to the early 1990’s. The prevailing belief in a reliable tendency to return to some normal degree of inclusion has little ground to stand on. True, most recessions are reversed, just as most booms end. Nevertheless, what is “normal” is itself shifting all the time.

Many argue that subsidies of any kind should never be countenanced, in part because they are extremely difficult, if not impossible, to abolish, even if they are no longer needed. According to this view, the total payment to a factor of production should not exceed its marginal productivity, so desirable outcomes should be promoted through tax incentives.

But, as early twentieth-century theorists pointed out, collaboration and exchange within a nation’s diverse labor force increase everyone’s productivity. There is a mutual gain from economic cooperation in addition to what each type of talent could produce independently – an insight later built on by the philosopher John Rawls.

A society can let the free market distribute this gain, or it can intervene to direct it to the least advantaged, so that some get more than their marginal product, others less. Since the least skilled workers face morale problems that lower their wages and erode their employability, it makes sense to deliver the mutual gain that is redistributed to them through subsidies that encourage greater self-support and employment. And, unlike tax incentives, wage subsidies target only employment of low-wage workers.

Both Europe and the US must do more to promote low-wage workers’ inclusion. A good economy not only sustains growing output and national income; it also ensures its participants’ capacity for self-sufficiency and ability to realise their potential. A substantial low-wage employment subsidy is a fair and efficient way to achieve this important goal.

Copyright: Project Syndicate 2005.

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the case for wage subsidies

There was another well publicised wage subsidy scheme which the Federal Government operated for many years - the CDEP scheme in Aboriginal communities.

This was to give the impression to the workers that they had "real" jobs and did real work.

I was typified by massive fraud and abuse and going by the level of social dislocation of such communities, it didn't really help anyone.

Work is only worth what someone is prepared to pay for it. A worker will only work if he/she considers the time engaged is worth wages he receives.

If people are paid while they are not working then to entice that person to work will take a lot more money. Wages controls will also increase that price. If the price then required is more than the work is worth, the business won't bother as the result is detrimental to his business. Greedy bastards all of them but that's a fact of life.

So the combination of welfare payments for people who don't work plus minimum wage laws for those unskilled means that unskilled workers cannot get jobs. Rising unemployment is the result and the government must intervene to stem the escalation.

The solution is not to do something about the actual cause of the problem, but to treat the symptom. This involves wage subsidies paid to employers to lower the cost of the employee back to what the work is actually worth. Wages subsidies explicitly recognise the fact that minimum wage laws and welfare payments for the able-bodied cause unemployment.

Work is more than wages

Michael Xavier, you say, “Work is only worth what someone is prepared to pay for it. A worker will only work if he/she considers the time engaged is worth wages he receives.”

This is absolute rubbish, what about all the work done by volunteers in our community? Often there is no one prepared to pay, for example volunteer bush fire brigades, caring for the sick or elderly, environmental restoration, the list goes on.

Work is not judged by its dollar value alone. lots of people work for reasons other than wages.

I once worked for a “work for the dole scheme.” We built a swimming pool for a small community, It provided work and it was of value to the community.

Work is more than wages

John Pratt, you worked for a "Work for the dole scheme" because you had to to get your welfare payments.

The community swimming pool was provided as a subsidy from the government to the community. It was a "make work" program. Such programs are well loved by bureaucrats because they can build their careers administering them.

We think its great because we see a swimming pool at the end of it. Who knows what the real cost of it is? Who cares? That community didn't have to pay for it.

The resources that went into the building of that pool were taken from people who would have done something else with those resources and provided employment to people in doing so. This is the loss that you don't see.

People do voluntary work for any number of reasons. I do it myself because it assists my children; others do it because it provides them with satisfaction. None of that voluntary work is possible without the productive capacity of businesses which underpins it all. Businesses do not operate for charity. They would inevitably fold unless of course they are constantly bailed out by governments.

It is productive, profitable businesses that enable us to experience the standards of living we enjoy. It beggars belief that businesses are painted as evil.

Where are the workers anyway?

Michael: You say “It is productive, profitable businesses that enable us to experience the standards of living we enjoy. It beggars belief that businesses are painted as evil”.

I agree but to be profitable businesses need workers and in the bush at least, they are just not there. There is a very real labour crisis. Notwithstanding there is a large number of people on welfare in the towns around us, if we lost the one person who is prepared to work in our district, we would literally have to call it a day and let the property go. Even his three strapping young sons have now left to work in the mines. So when he goes so will we.

Like most of our neighbours we are getting too old to slog as hard as is needed to keep the place from being overrun with woody weeds, stop the fences falling down and so forth.  Farmers can simply no longer get workers and even if they could, the add-on costs to the wage make it prohibitive when the industries are staggering under such economic pressures from drought and low commodity prices. If the sons see no reason to stay you cannot blame others for not wanting to do the work that is physically very demanding, and in our area it is also very isolated and lonely. I can only point to one son working with his father on a property within a 100-200 square kilometre area around us now, whereas 10 years ago there were about 7-8. The homesteads where those families lived are now mostly abandoned.  

Rural commodity prices are the big issue and with the EU and US subsidies, any real improvement is not likely to occur.  It never ceases to amaze me that the supermarkets here can ask $15 for a good steak and we farmers get less than $2 for the same steak. It is simply not worth the effort and we have now basically just let the roos and some agisted cattle have the place, all 2200 acres of it.  If it was profitable we would bring it back into full production and be able to pay people to work, if we could find anyone, and that is the real issue. They are just not there any more. Wage subsidies and the like schemes are not likely to solve what is basically a manpower problem in an ageing rural population. 

It is hard to see the future for areas like ours if there are no young people left.  Without workers, the work will just not get done. You can see it everywhere, infrastructure such as fences just falling down. No money to fix them, and no one to fix them.

paying people not to work

The same thing happens in places like Bundaberg where growers find it difficult to get pickers even where a place like Bundaberg has a very high unemployment level. They are able to get by using overseas backpackers for their seasonal work. The work is physically demanding so the local layabouts don't want to do it.

The backpackers are keen to make as much money as they can as quickly as possible to fund their holidays so they are generally reliable.

It's time that paying people not to work when work is available was ended.

In more remote places that do not attract tourists in large numbers, then getting labour becomes a big problem, especially when the business has to compete internationally with a local cost structure that is underpinned by welfare payments.

Wage subsidies

While somewhat dissimilar to what is described here (and I do not know if the scheme is still running), I recall hiring quite a few long term unemployed under a Federal wage subsidy scheme on our rural property in the 1980s. The scheme paid employers a large part of the employees wage for a limited period, and I recall the longest period was for about 9 months for those who had been out of the workforce for a year or more. The scheme was designed to get the long term unemployed back into the workforce with a requirement on the part of the employer to provide supervision and skills training. The incentive to the employer was the substantial wage subsidy.

Over some years we took on quite a few of these workers but it was never successful. Some employers simply put them off when the subsidy period ran out, seeing the scheme as a way to get cheap labour. We did not. If they had learnt the skills we needed we always tried to keep them on but even so, most of them left after short periods.

The problem was not that the wage was low, as employers were obliged to pay award wages with all the associated conditions of employment. For us the scheme failed because the workers themselves were by and large not committed to employment in any form and as a result had all sorts of attitudinal problems. They would turn up late, would constantly ask for wages in advance, then fail to turn up at all and we would then start all over again with someone new. The time invested in training simply never paid off.

There was the odd exception and they stayed with us for several years becoming reliable employees. But out of the dozen or more we took on and tried to train, they were a very small minority. We had greater success with younger people on apprenticeship schemes.

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