Mon, May 01, 2006 - Page 9 News List

Subsidized wages the key to better labor market participation

By Edmund 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 US, 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 demoralized 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 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 marginalized 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.

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