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October 02, 2017

Wage subsidies may not help to increase employment among older workers

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As populations age in industrialized countries, the labor market participation of older workers becomes increasingly important—not only in order to safeguard the financing of public pension systems, but also to maintain a sufficiently large workforce. Over the last two decades, employment rates among the population aged 50 and above have increased in most industrialized countries. This has mostly been due to longer employment relationships. But it remains particularly difficult to integrate older workers back into work once they have moved into unemployment or non-participation.

One way to incentivize employers to hire or retain older workers is to pay them wage subsidies. These compensate employers for the gap between workers’ pay and productivity, as this gap is often responsible for employers’ unwillingness to employ older workers. Salaries tend to increase with age, due to deferred compensation schemes, collective bargaining agreements, or for other reasons, while productivity lags behind or even declines.

There is only limited empirical evidence on policies that target wage subsidies specifically to older workers. In the case of Germany, an evaluation of a subsidy program found that hiring subsidies did not lead to more hiring nor to earlier transitions from unemployment to employment, compared with a situation in which no subsidies were available. While there were large positive effects on subsidized employment, the effect on total (subsidized plus unsubsidized) employment was far lower. In other words, subsidized hiring merely replaced unsubsidized hiring.

Inducing employers to hire older workers whom they would not have hired without the subsidy may be a very ambitious objective. Perhaps it is easier to increase retention of older workers. Two examples from Finland and Belgium show that wage subsidies may indeed prevent premature transitions to early retirement. In Finland, a large-scale wage-subsidy program was available from 2006 to 2010 for all low-wage workers aged 54 years or older. Importantly, it covered only full-time workers. Finnish workers are entitled to switch to part-time early retirement 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 younger, unsubsidized age groups.

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. An increase in employment occurred only in the manufacturing sector, where most workers have the option of taking early retirement. Again, this indicates that the subsidy made early retirement less attractive.

Wage subsidies do not seem to boost employment in the workforce as a whole, and they are not appropriate instruments for increasing the hiring of older workers. Alternative policies, such as providing training, may be more effective. The results for Finland and Belgium suggest that wage subsidies for older workers may be effective in preventing early retirement. However, rather than mitigating early retirement incentives by wage subsidies, removing these incentives altogether might be an even more efficient policy.

Related article: The effects of wage subsidies for older workers

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We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.