The effects of wage subsidies for older workers

Theoretical arguments for employer wage subsidies

Employer wage subsidies are not a new policy instrument, and their effects have been analyzed since the 1930s [5]. Wage subsidies lower the net wages paid by the employer. In competitive labor markets, the strength of the employment effect depends on the responsiveness of labor demand and supply to wages (wage elasticity). If either is inelastic, the subsidy will not enhance employment. The only effect would then be a financial gain to either the employers or the employees, depending on which side reacts inelastically to the change in wages [1].

In many countries, wage subsidies are targeted to disadvantaged groups, such as younger or older workers, low-skilled workers, and workers with disabilities. The employment effects may turn out to be different for these groups of workers than for workers in general. If wages are fixed because of deferred compensation schemes (in the case of older workers) or collective bargaining agreements, and if employment cannot fall below a certain level because of employment protection legislation, a gap between pay and productivity may arise [6]. A moderate wage subsidy—one that reduces the pay–productivity gap but does not close it—would not lead to additional hiring. Only a large subsidy—one that raises the marginal product of labor plus the amount of the subsidy above the fixed wage level—will induce additional employment.

This discussion does not distinguish between changes in employment because more people work and changes in employment because the same number of people work more. Subsidy programs do make this distinction. Subsidies that are proportional to wages provide incentives to increase both the number of hours worked (working more) and the number of workers, while subsidies paid only for new hires affect the number of people who work.

For older workers, the size of the pay–productivity gap depends on the changes in workers’ productivity over their lifetime (an issue on which there is conflicting empirical evidence) and the trajectory of wages. This suggests that there are interactions between wage subsidies and other labor market institutions, in particular legal employment protection.

More recently, wage subsidies have been analyzed in the framework of the search and matching model [7]. In this framework, age and employment subsidies boost employment, especially among low-skilled workers, while hiring subsidies reduce the duration of unemployment but increase its incidence. However, the larger deadweight effects of employment subsidies make them inferior to hiring subsidies from a welfare point of view [5].

Empirical results: Effectiveness of wage subsidies on hiring

Germany introduced hiring subsidies in 1998 (called the integration supplement, or EGZ) to be paid for a limited time after an unemployed worker was reintegrated in the labor market [1]. Eligibility criteria for target groups have been changed several times. For older workers, the maximum amount was 70% of labor costs (wages set by collective bargaining agreements plus payroll taxes) and the maximum duration of payments was 70 months. In most cases, local employment agencies chose to remain substantially below these limits. If the employment relationship is terminated before a minimum period after expiration of the subsidy, the employer is legally obliged to refund parts of the subsidy. There is no legal entitlement to the integration supplement; decisions on the amount and duration of the subsidy are made by the agency.

An evaluation of the program looked at whether hiring subsidies led to more hiring and, thus, to earlier transitions from unemployment to employment compared with the situation in which no subsidies are available [1]. The observation period was shorter than the maximum duration of benefits, so the study did not consider long-term integration into unsubsidized employment.

As have other studies of wage subsidies for all workers, the study used a difference-in-differences approach, exploiting changes in eligibility. For instance, a change was introduced in 2002 that extended eligibility from the long-term unemployed to all unemployed workers aged 50 and older. Drawing on a large database of administrative records, the study compared workers aged 50–50.5 years at the time they entered unemployment (eligible workers—the treatment group) and workers aged 49–49.5 years (non-eligible workers—the control group) [1]. Data were collected on both age groups before and after the legal change. Members of the two age groups within the two time periods were followed up to 180 days after the start of their unemployment spell. The outcome measure was whether those who were unemployed were hired during that period (not counting employment in public schemes).

The probability of remaining unemployed after 180 days from the start of the unemployment spell increased between 2001 and 2002 among the control group because of deteriorating labor market conditions but became slightly smaller among the treatment group (a smaller value indicates a more positive outcome) (see Illustration). Thus eligibility reduced the probability of remaining out of work; however, the effect was found to be non-significant. A similar finding was obtained for another change in 2004 which restricted eligibility, but with the effects reversed.

The study also looked at whether unemployed workers who were reintegrated into the labor market transitioned into subsidized or unsubsidized employment, again exploiting the 2002 change that extended eligibility from the long-term unemployed to all unemployed workers aged 50 and older [1]. The change in legal eligibility criteria had relatively large positive effects on subsidized employment (neglecting possible effects on unsubsidized employment) in the treatment group (Figure 1). Measured as a share of all unemployed workers, the results show a two percentage point increase in the probability of exiting unemployment to subsidized employment. This effect is much larger than the effect on total (subsidized plus unsubsidized) employment (shown by the curve labeled “All exits from unemployment” in Figure 1). The difference between the two estimates is explained by the lower number of exits into unsubsidized employment as a result of the subsidy. Hence, deadweight effects dominate employment creation.

Further analyses incorporated workers’ characteristics, possible anticipation effects (such as a reduction in hiring just before the policy change went into effect), and different definitions of age groups or outcome variables [1], but the results were unchanged. In addition, the findings strongly suggest that the ineffectiveness of the policy is due to a deadweight effect and not to displacement or substitution effects, taking into account the narrow definition (in terms of age) of the comparison groups.

Figure 1 is based on the amount of hiring within the same age group; substitution and displacement would affect mainly workers outside this age group. Thus, in most cases, the same workers would have been hired even without the subsidy.

Empirical results: Effectiveness of wage subsidies on overall employment

In Finland, a large-scale wage-subsidy program was temporarily available from 2006 to 2010 for all low-wage workers—whether previously employed or unemployed—who were 54 years old or older. The maximum amount of the subsidy was 16% of gross monthly earnings for workers earning €1,400 a month and was available only to those earning less than €2,000 a month. The subsidies were less generous per period than in the German reintegration program but they could be received for a longer period. In addition, the design of the subsidy created employment incentives not only to hire new workers but also to increase working hours because it covered only full-time workers who were employed at least 140 hours a month. The objective of the subsidy was to increase employment among low-skilled workers and to provide incentives against early retirement.

An evaluation of the program used a 33% sample from the Finnish Longitudinal Employee-Employer Data, an administrative data source covering the entire population of Finland [8]. The data contain tax records and wage information but no direct information on subsidy receipt. The treatment variable was eligibility for the program. The study used a difference-in-differences-in-differences design based on the introduction of the subsidy in 2006, age (taking into account the age limit of 54 and that younger workers may become eligible in the future), and low-wage status (less than €2,000 a month).

The study finds a one percentage point increase in the employment rate for the low-wage group, a half a percentage point increase for the high-wage group (individuals likely to be ineligible for the subsidy), and a half percentage point difference between the two (the treatment effect, as estimated by the difference-in-differences-in-differences estimator [8]). The effect of the subsidy is only marginally significant. And because the subsidy was received by about 60% of all eligible workers and cost about €90 million a year, the effect is also small in magnitude. These results are confirmed by regression analyses that account for worker characteristics. An analysis using the size of the subsidy (or likely size in the case of the treatment group) rather than eligibility as the treatment variable found labor demand elasticities of 0.07–0.13, suggesting that demand for labor is inelastic, e.g. does not respond to these incentives/changes. No significant effects were found for the number of newly hired workers [8].

Thus, the policy appears to be ineffective in bringing the unemployed back to work.

Interactions with early retirement policies

The Finnish subsidy program may have had a variety of effects on the hours worked by employees, depending on how the amount of the subsidy changed with hours worked and total remuneration. Because the subsidy was available only to full-time workers, its most important effect may be that it provided an incentive for employers to offer full-time instead of part-time employment.

This is particularly relevant because Finnish workers are entitled to switch to part-time early retirement arrangements at age 58. The wage subsidy could make this early retirement choice more costly to employers than subsidized full-time employment. Indeed, the share of the age group 58 years and older working part time fell substantially after the subsidy program was introduced, while there was no change in the younger age groups [8]. Thus, the subsidy was effective in counteracting the incentives for early retirement created by other programs.

Belgium introduced a similar policy in 2002, a permanent wage subsidy (a reduction in employers’ social security contributions) targeted to workers aged 58 or older. The program reduces private sector employers’ social security contributions by €400 a quarter for employees in the targeted age group who work at least 80% of a full-time-equivalent job. Calculated at the median wage, the subsidy was 4% of the wage cost—a substantially smaller incentive than in the German reintegration program discussed earlier. The incentive is strongest for workers earning close to the minimum wage. Part-time employees working 33–80% of a full-time-equivalent job also benefit, but the subsidy is reduced proportionately to working time.

The program becomes available to workers at age 58, the age at which early retirement becomes an option for a sizable share of Belgian workers, in particular manufacturing workers. For this subgroup, it serves explicitly as a counteracting force to incentives for early retirement.

A study of the program hypothesized that a wage subsidy might not affect employment decisions for all workers but that it might reduce the attractiveness to employers of dismissing workers through early retirement [9]. The study used a large data set that merges administrative records of different origins and provides information on close to 250,000 workers. The outcome variables examined were the employment rate, working time, and hourly wages. The study used a conditional difference-in-differences approach that compared workers above and below the age limit of 58 and before and after the introduction of the policy to estimate the effects of the policy. If the wage subsidy is effective, the study would be expected to show a smaller drop in employment at age 58 after the policy was introduced.

Despite the large number of observations, the results for all workers are statistically insignificant. This finding is in line with the results obtained for Germany [1] and Finland [8]. However, in manufacturing, where most workers have the option of taking early retirement, the effect of the subsidy is larger and significant for men, though not for women [9]. The effect is also significant for workers in companies where a large share of workers had taken the early retirement option before the subsidy was introduced. In that group, a labor cost decline of 10% increases the probability of being employed by 9%, implying that labor demand reacts relatively elastically to changes in labor costs. The study also finds a significantly positive but small effect on number of hours worked.

The results for Finland [8] and Belgium [9] suggest that wage subsidies to older workers may be effective in preventing early retirement. However, wage subsidies do not boost employment in the workforce as a whole, and they are not appropriate instruments for increasing the hiring of older workers.

Differences across subgroups of the target population

It is plausible that the effects of wage subsidies differ across population groups, such as between low-wage and high-wage workers or between the long-term and short-term unemployed. And deadweight effects could be lower in groups in which there would be little hiring in the absence of the subsidy. Unfortunately, there is little systematic evidence to support or refute these differences. In particular, it is difficult to compare the effects of the subsidies between low-wage and high-wage workers if the amount of the subsidy (relative to wages) depends, as in Belgium and Finland, on the wage before subsidies.

The German study considered the effect on four population groups: men and women in eastern and western Germany [1]. Of these groups, significant employment effects are found only for women in eastern Germany. One reason for the stronger effect for eastern Germany may be that the hiring subsidies are more generous than in western Germany: the duration of subsidies is, on average, considerably longer in eastern Germany than in western Germany. In western Germany, only one-third of the subsidies last between two and three years, while in eastern Germany more than two-thirds do. Thus, the incentives for hiring are stronger in eastern Germany. This, however, does not explain the differences between men and women in eastern Germany.

In addition, women in eastern Germany may be a special case because of the high rate of unemployment in this group: 19.3% in 2000–2004 compared with 8.1% in western Germany [1]. High unemployment results in a high elasticity of labor supply, so wages are unlikely to rise in response to the subsidy. At the same time, the level of education and work experience of women in eastern Germany is high, so the initial pay−productivity gap may be low relative to the subsidy. Further analysis shows that the positive effect of the subsidies on hiring is confined to skilled and semi-skilled workers.

The studies of the subsidy programs in Belgium and Finland also looked at the gender effects. The Belgian study finds statistically significant effects for men but not for women, which can be attributed to the lower employment rate among women [9]. In addition, fewer women work in manufacturing, where the results are most significant. In Finland, the subsidy is equally ineffective among women and men [8].

Other factors influencing the effects of wage subsidies

Evidence shows that the effects of wage subsidies for older workers are affected by the existence of early retirement schemes and are likely affected by other policies, such as employment protection and wage-setting institutions. Furthermore, the effects could differ with macroeconomic conditions. A recent study of a temporary tax credit scheme in France (the “zéro charges” program enacted in 2008) finds a positive effect on employment during the recent recession [10]. It is not clear, however, to what extent this finding applies specifically to older workers.

Wage subsidies, if targeted to particular groups or paid on a case-by-case basis, may create stigma effects by signaling to employers that productivity is lower among these workers. To examine this issue, the effectiveness of hiring subsidies for people with disabilities, offered through Swiss Disability Insurance, was analyzed in a small-scale social field experiment [11]. The results show that for clients of job coaching services, callback rates for job openings increased if employers were made aware of the subsidy. In another group (vocational training graduates), however, the subsidy was counterproductive. The issue of stigma effects of targeted wage subsidies needs additional investigation.