Introduction

In both Europe and the United States policy makers have been searching for new labor market measures that keep unemployment low and avoid large disparities in income. This chapter examines two policy proposals that have this aim: (1) unemployment vouchers and (2) low-wage subsidies. The unemployment vouchers are targeted exclusively at the unemployed (especially the long-term unemployed) and are provided for only a limited period of time. The low-wage subsidies, on the other hand, are granted to all low-wage earners regardless of their employment history and are of limitless duration.

Naturally, the impact effects of unemployment vouchers and low-wage subsidies are quite different. Because unemployment vouchers are targeted typically at the long-term unemployed whereas low-wage subsidies are targeted at the low-wage employed, it may be tempting to think that the two policies address different government objectives, namely, that the unemployment vouchers fight unemployment whereas the low-wage subsidies combat working poverty. This impression is misleading, however. Both policies affect the incentives to work. Thus both policies influence both unemployment and working poverty.

The unemployment vouchers are meant to reduce unemployment and inequality by stimulating the employment of those who are currently longterm unemployed; the low-wage subsidies pursue these dual objectives by promoting the employment of the working poor. Broadly speaking, the former promotes equity by reducing unemployment and the latter reduces unemployment by promoting equity.

The effectiveness of the policies in stimulating employment versus alleviating poverty depends on the degree to which their incidence falls on employers versus employees.

Introduction

Sweden recently implemented a pension reform that includes a system of individual accounts giving individuals substantial flexibility in their choice of investments. At the same time, other Swedish social insurance systems such as unemployment insurance, sickness benefits and parental leave have remained unchanged. Like numerous other OECD countries, Sweden faces a serious challenge in welfare policy-making. Existing welfare benefits are associated with substantial market distortions and create disincentives to work.

This chapter examines the possible effects of introducing a large-scale welfare reform in Sweden, namely, the introduction of comprehensive welfare accounts. Under this policy, individuals make mandatory contributions to accounts, which they can top up with voluntary contributions. In return, individuals’ welfare benefits are paid from their accounts. Moving from the traditional tax-financed welfare systems to a welfare account-based system involves replacing general taxes by mandatory saving to finance the requisite welfare benefits. The welfare accounts are hence like ordinary savings accounts with two key exceptions. First, to avoid problems of moral hazard, there are restrictions on withdrawals from the welfare accounts. And second, the welfare accounts also serve a redistributive function, so that individuals receive specific minimum welfare benefits regardless of how low their account balances may be. Such accounts are in place on a comprehensive basis in Singapore, and for specific benefits such as unemployment, health and education in the US, Chile and Brazil.

In order to motivate the introduction of welfare accounts, we note that social insurance programmes involve a combination of savings, insurance and redistribution.

Introduction

The spirit of this tale goes a long way towards explaining the evolution of unemployment policy in many EC countries and elsewhere. The policy is to pay people when they are unemployed and tax them when they find jobs. So, far from inducing workers to seek employment and firms to take them on, the policy in fact discourages them from doing so and thereby contributes to the unemployment problem. Having done so, the unemployment benefit system is then seen as particularly essential in providing a safety net for those out of work. This is not the only occasion on which economic policy creates the problem it is meant to solve, but it is particularly unconscionable in times of recession, when unemployment becomes a flagrant waste of human resources.

If the money governments spend on unemployment benefit could be redirected so as to provide an incentive, rather than a disincentive, for employment, many countries struggling with the twin burdens of high unemployment and costly unemployment benefits might reap a substantial benefit.

Introduction

This chapter is motivated by a simple idea that has received lamentably little attention in the literature on unemployment policy: different unemployment policies are generally based on different theories of unemployment, and our confidence in a policy should depend – at least in part – on the ability of the underlying theory to account for some prominent empirical regularities in unemployment behaviour.

Some theories depict unemployment as the efficient outcome of market activity. These usually serve to rationalise a laissez-faire policy stance. Others depict unemployment as the product of market failures. Here, unemployment must be seen as the symptom of many possible diseases: many different market failures can produce the same problem of joblessness. And just as different diseases require different treatments, so different market failures may call for different government policies. It is because different theories of unemployment focus on different market failures that different policies are generally based on different theories.

It is difficult to evaluate the various unemployment policies by assessing the practical significance of the market failures identified by the underlying theories. After all, market failures arise when people are not fully compensated for the costs and benefits they impose on one another, and uncompensated costs and benefits are inherently difficult to measure. For this reason, it is natural to evaluate unemployment policies by investigating the predictive power of the underlying theories.

When it comes to unemployment, economists and policy makers have lost their innocence. There was a time when broad agreement prevailed on what caused unemployment, and what governments should do about it. Since then we have awoken from this comforting dream and have come to recognise that unemployment can have a wide variety of potential causes, matched by a similar variety of policy responses. The trouble is that, in practice, the causes are difficult to identify and the policies difficult to evaluate. This bewildering state of affairs provides the rationale for this book, made possible by the generous financial support of Consorcio de la Zona Franca de Vigo. Its aim is to provide an overview of the available unemployment policies, a rigorous analysis of how they work, and an assessment of their robustness in the face of unemployment's multiple causes.

Before embarking on this undertaking, it is important to be aware from where we have come. The world used to be so simple. In the first two decades of the postwar period, economists were agreed that governments could spend their way out of unemployment. Their diagnosis was straightforward and so was their policy prescription: unemployment was due to an insufficient demand for labour, and firms were not demanding enough labour because there was an insufficient demand for their products. So, if the private sector of the economy was not spending enough, then the government could reduce unemployment by spending more itself.

Purpose of the volume

Large-scale unemployment has become the prime social, economic and political issue in Europe and a number of other OECD regions. It is a colossal waste of human potential and national product; it is responsible for poverty and inequality; it erodes human capital; it creates social and political tensions wherever it strikes. In the last few years a large number of books, reports and papers has been published, most of them attempting to analyse the ascent of European unemployment, but very few have focused on the policies necessary to reduce it. This volume is an attempt to fill this gap.

In most countries where unemployment is a major problem, it is product of several simultaneous causes, each of which interact with the rest: small wonder that unemployment policies are difficult to design. Moreover, many policies that could improve economic efficiency are not politically implementable. The political realities dictate that it is not enough to find policies that give more jobs for those currently unemployed than they take away from those currently employed; it is vital that those who stand to gain are in the political majority.

This volume attempts to deal with these problems head-on, and this requires a break with a hoary academic tradition. The tradition is to write papers that develop detailed theoretical and empirical models of unemployment and to include a short section at the end about vague ‘policy implications’.