Tackling Unemployment

The twin problems of unemployment and the public deficit make it imperative to search for low-cost schemes that can help to stimulate employment creation. “Marginal employment subsidies” were much discussed in the international literature in the early 1980s and might have a role to play today.  

A specific and fairly modest proposal to start with would be to abolish employers’ PRSI contributions for new jobs; i.e. for any increase in a firm’s employment over and above the level recorded at a specific date in the past, e.g. X/X/2010. (The importance of choosing a date in the past is that it would prevent firms gaming the policy by shedding jobs in advance of its introduction). This avoids the extensive deadweight losses associated with e.g. a cut in employers’ payroll costs. There would still be some deadweight loss in tax revenues resulting from jobs that would have been created anyway, but it seems unlikely that there is much new employment creation at present. The proposal would amount to a wage subsidy of over 10% for new jobs. (If it looked like it was starting to have an effect, it could be extended by taking into account some of the resultant savings in social welfare).

Care would need to be taken to prevent firms closing down and establishing under a new name to exploit the scheme, but I assume this could be surmounted.  

Many of the existing schemes in place today (details here) might be thought similar to the present proposal. Most are targeted however at particular groups of disadvantaged workers, which make them less likely to succeed, and, as far as I recall, some displacement effects were found. The present proposal avoids these.

The proposed scheme might be gradually wound down as follows: the implicit subsidy to be reduced by Y% for each 50,000 jobs recorded in the economy over and above the level prevailing at X/X/2010.  

If the economy were solely cost-constrained, the proposal would raise employment through both the output and substitution effects. The substitution effect will still apply if the economy is purely demand-constrained, and by getting people back to work will have beneficial demand effects. 

Examples of the literature from the 1980s include:

Chiarella, C., and A. Steinherr (1982), “Marginal employment subsidies: an effective policy to generate employment”, Commission of the European Communities, Paris, Commission of the European Communities Economic Papers No. 9, November.  

Layard, R., and S. Nickell (1980) “The case for subsidizing extra jobs”, Economic Journal, Vol. 90 pp.51-73.  

Oswald, A. J. (1984) “Three Theorems on Inflation Taxes and Marginal Employment Subsidies”, Economic Journal, 94, 375.  

Whitley, J. D. and R. A. Wilson (1983) “The Macroeconomic Merits of a Marginal Employment Subsidy”, Economic Journal, 93, 1983.  

See also:
Snower, D. (1994), “Converting unemployment benefits into employment subsidies”, American Economic Review, Vol. 84 pp.65-70.

The Fine Gael “Black Hole”?

I was accused yesterday in the comments of being biased against Fine Gael and for Labour. However, today I’m going to have to wave the yellow card at Labour for their role in the ongoing rumble about fiscal plans, specifically the supposed €5 billion “black hole” (e.g. here and here) in Fine Gael’s budgetary plans.

The issue relates to the following statement on page 29 of European Commission’s report on Ireland:

If the consolidation to reduce the deficit to 3% of GDP needed to be achieved by 2014, this would risk choking the recovery and further weakening the banking sector, possibly resulting in additional budgetary costs. The necessary additional budgetary effort in 2011-14 would amount to around €4 ½ to €5 bn, according to the Commission services forecast.

Fine Gael’s plans use what they call “the Department of Finance’s forecasts”, which presumably means the growth projections in the four-year plan (though it would be nice if they said that and produced a table being explicit about how their growth assumptions and other spending and tax promises translate into deficit ratios.) Based on this, they project reaching a deficit of 2.8% in 2014, just like the Four Year Plan.

Since FG are promising to deliver a deficit below 3% in 2014, does the Commission’s statement mean there is a €5 billion “black hole” in FG’s plans? Well, no. The additional adjustments that the Commission believe would be necessary to reach the 3% target stem from the Commission’s lower forecasts for the growth rate of nominal GDP. The Commission projects an average growth rate of 3.1% for nominal GDP over 2011-2014, compared with 3.9% in the Four Year Plan (and 3.85% in Labour’s projections.)

This means lower GDP and higher deficits in 2014 than are projected by the government and FG. However, FG are explicit that they will not introduce additional cuts to meet the 3% target in 2014:

We will review the pace and timeframe of the fiscal adjustment with the EU and IMF on an annual basis to take into account developments in the real economy. Should growth rates disappoint, we will continue with the same level of fiscal adjustment, but will avail of the extra year to reduce the deficit to under 3% of GDP offered by the EU-IMF Programme of Support.

Of course, it’s questionable whether the 3% target can be achieved by 2015 either and the IMF, freed from the strictures of having to pretend the Stability and Growth Pact matters, forecast that it won’t be.

Anyway, the black hole business is unfair to FG and the truth is that the differences between the overall stance of fiscal policy being proposed by FG and Labour are fairly small. FG planning to implement €9 billion in adjustments over the next three years, while Labour are planning to implement €7 billion. One can debate whether a slightly slower pace of adjustment is a better idea but the fact remains that policy will be severely contractionary whichever party gets its way.

When looking for black holes in the Fine Gael plan, one would be better off focusing on whether the promised efficiency improvements can really generate the predicting savings on the spending side.

Unintended consequences, academic edition

Colm Harmon has a nice little piece on some (possibly) unintended consequences of current government higher education policy here.

Gormley On the Guarantee: The McWilliams Option

John Gormley on tonight’s Vincent Browne show:

Gormley: We had already discussed it for about a week on and off, we had discussed this. Some people, and I took the view too, that maybe nationalisation was the way forward. You have to remember the context.

Vincent Browne: You didn’t think that you as leader of the party that was in coalition government with Fianna Fail, you didn’t think that maybe you should get out of bed and go in to the Department of Finance where these discussions were going on.

Gormley: No because we had already discussed it Vincent. That’s the whole point

Vincent Browne: You went back to bed?

Gormley: Well, of course. I said “What is the option?” I remember speaking to Brian Lenihan and said “What option are we going for?” In fact, I can tell you what the exact words I used were “Are we going for the David McWilliams option?” That’s what I said on that particular evening. And he said yes. And as far as I was concerned that was the best option as I understood it at that time.

Vincent Browne: Because David McWilliams told you.

Gormley: Well, he is a person that I think a lot of people have respect for and we had discussed it. When I had mentioned nationalisation, he said “no, that’s not a good option at all.”

Vincent Browne: How come there was a bill presented to Brian Lenihan and Brian Cowen that night? There was a bill already drafted for the nationalisation of Anglo Irish Bank. How come that happened if nationalisation wasn’t on the table over the previous weeks or months?

Gormley: Well, that’s an interesting point because it’s the one that I have gone for myself, so I suppose the Department of Finance had just put that one in, just in case we didn’t decide for the guarantee.

The McWilliams Option might sound like a Robert Ludlum thriller. Unfortunately, this wasn’t fiction. This is a senior cabinet minister’s description of how the most important economic policy decision in the history of the state was made.

Fir Tree Capital Opportunity Master Fund LP v. Anglo Irish Bank Corp.

NAMA Wine Lake reports on this case.