Maarten Goos and Joep Konings (KUL)

1. preliminary The impact of employment subsidies on job creation: non-experimental evidence using firm level data Maarten Goos and Joep Konings (KUL)

2. motivation (1) • With the joining of China, India and the ex-Soviet bloc, there has been a “great doubling of the global workforce” and consequently a fall in the global capital-labor ratio especially for low-skilled manual workers. • Recent technological change driven by computerization is biased against low-skilled manual workers. • Both “facts” put pressure on low-skilled manual workers either in terms of their employment prospects or in terms of their wage.

3. motivation (2) • Whether wage dispersion or unemployment temporarily increases during this transition period depends on the degree of wage flexibility in the low-skilled labor market. • The literature suggests that wage flexibility will provide a smoother longer-run transition of low-skilled manual workers into other industries or skill-sets but that real wages are rigid in European countries. • Could it be that subsidizing low-skilled manual employment is an effective instrument to increase wage flexibility and maintain low-skilled manual employment at least in the short-run?

4. motivation (3)

5. motivation (4) • This paper will use a panel of Belgian firms to examine the impact of lump-sum employment subsidies for full-time manual workers known as the “Maribel subsidies” • Given that the Maribel subsidies introduced progressivity in payroll taxes, we will first provide a framework to analyze its impact under different assumptions about the nature of labor and product markets • Second, given that Maribel subsidies were not applied across the board and given that we have information about the actual subsidy received by each firm, a set a straightforward non-experimental evaluation techniques can be used to analyze the impact of Maribel subsidies on full-time manual employment.

6. presentation outline • a framework to understand the impact of Maribel subsidies on job creation • the history of Maribel • data • empirical analysis • conclusions

7. a framework (1) • A Maribel subsidy is a per-period lump-sum subsidy paid to the employer for each full-time manual worker employed at that firm. A framework is needed to understand the possible impact of Maribel subsidies on full-time manual employment. • This framework must account for the existence of a proportional payroll tax, wage bargaining between unions and firms and the fact that each of many firms has some product market power. • It will be argued that under realistic assumptions about labor and product markets, Maribel subsidies are expected to increase full-time manual employment.

8. a framework (2) • Assume the pre-tax and post-tax wage are given by: (1) with t the proportional marginal payroll tax and the lump-sum employment subsidy. • (2) and (3) and

9. a framework (3) » when the firm has no product and no labor market power « • A group of homogeneous firms maximizes profits: (4) with p possibly different from the economy wide aggregate price index normalized to unity and such that and . • (5) which for given p implicitly defines the unconditional demand for labor function.

10. a framework (4) » when the firm has no product and no labor market power « • Unconditional labor demand is given by: (6) with • Uncompensated labor supply is given by: (7) with • Setting (6) = (7) solves for employment and wages: (8)

11. a framework (5) » when the firm has no product and no labor market power « • Totally differentiating (8) wrt the pre-tax wage and the employment subsidy gives: (9) (10) and • Maribel subsidies are expected to increase full-time manual employment if labor and product markets are perfectly competitive

12. a framework (6) » wage-bargaining when the firm has no product market power « Assume unions and firms bargain over the pre-tax wage and firms then choose the level of employment: (12) with .

13. a framework (7) » wage-bargaining when the firm has no product market power « • It must be true in equilibrium that: (13) • The impact of employment subsidies on the pre-tax wage is: (14)

14. a framework (8) » wage-bargaining when the firm has no product market power « • Remember from (9) and (10) that and • An increase in employment subsidies decreases employment if is larger than 1/[1+t]. An interesting question is under what conditions employment subsidies lead to job destruction rather than job creation (as was true for perfectly competitive labor markets).

15. a framework (9) » wage-bargaining when the firm has no product market power « • A necessary condition for (14) to be larger than 1/[1+t] is that • Given the concavity of the Nash-bargain in pre-tax wages, this implies employment subsidies decrease employment only if: (16)

16. a framework (10) » wage-bargaining when the firm has no product market power « • For Maribel subsidies to decrease full-time manual employment, the labor demand function must be sufficiently concave and/or, in absolute value, the elasticity of labor demand must be sufficiently small relative to the elasticity of profits. • This excludes a wide range of production technologies including the commonly assumed case of isoelastic production functions.

17. a framework (11) » wage-bargaining when the firm has no product market power « E.g. Cobb-Douglas technology in the single factor case

18. a framework (12) » wage-bargaining when the firm has no product market power « • Therefore, for a wide range of production functions • In sum, assuming wage bargaining, Maribel subsidies are expected to increase full-time manual employment under standard assumptions about production technologies.

19. a framework (13) » wage-bargaining when the firm has product market power « • So far we have looked at conditions imposed on production technologies for employment subsidies to increase employment assuming labor markets are imperfectly competitive. • But there imperfect competition on output markets too in the data examined below. In particular, a common assumption is that of monopolistic competition assuming that each takes the actions of other firms as given.

20. a framework (14) » wage-bargaining when the firm has product market power « The Nash-bargain is now given by: (18) where is implicitly given by

21. a framework (15) » wage-bargaining when the firm has product market power « • In line with the case where the firm is a price taker, employment subsidies decrease employment only if: (19) • This excludes a wide range of production technologies including the commonly assumed case of isoelastic production technologies and isoelastic product demand.

22. a framework (16) » wage-bargaining when the firm has product market power « E.g. Cobb-Douglas production technologies and isoelastic product demand in the single factor case

23. a framework (17) » wage-bargaining when the firm has product market power « In sum, under realistic assumptions about production technologies and product demand, Maribel subsidies are expected to increase full-time manual employment:

24. presentation outline • a framework • the history of Maribel • data • empirical analysis • conclusions

25. the history of Maribel (1) Table 1: The history of Maribel

26. the history of Maribel (2) Table 2: Maribel II/III

27. the history of Maribel (3) Table 3: Maribel IV

28. presentation outline • a framework • the history of Maribel • data • empirical analysis • conclusions

29. data (1) • BELFIRST: a panel of company accounts for the period 1995-1999 • Header and balance sheet: firm identifier, industry classification, average annual employment at the firm • Social balance sheet: total full-time, full-time manual, part-time manual and full-time non-manual employment on 31/12, annual hours worked by full-time workers, average annual full-time employment, average annual part-time employment and annual Maribel subsidy received by the firm

30. data (2) Table 4: Comparing BELFIRST

31. data (3) Table 5: Subsidized and non-subsidized firms in BELFIRST

32. data (4) Table 6: Firm level Maribel subsidies in BELFIRST

33. data (5) Figure 2: Actual and predicted total subsidies for Maribel II/III in 1996

34. data (6) Figure 2 (cont.): Actual and predicted total subsidies for Maribel IV in 1998 given that X>0.66

35. presentation outline • a framework • the history of Maribel • data • empirical analysis • conclusions

36. empirical analysis (1) • The aim of this section is to derive treatment-on-the-treated effects of Maribel subsidies on full-time manual employment. • Since Maribel has been an uncontrolled experiment, one has to make choices about how to construct counterfactuals. • This section uses the different possibilities with the data at hand applying DID, matching and IV estimators • In line with the theory presented above, it will be argued that Maribel subsidies have increased full-time manual employment indeed.

37. empirical analysis (2) • Difference-in-differences estimates compare the within-firm variation in employment between firms switching Maribel participation and firms not switching Maribel participation. • Combining years 1996-1999 allows us to apply the fixed-effects estimator to the following functional form: (21) • Allowing for an arbitrarily different time trend for firms having ever received Maribel subsidy does not change the difference-in-differences estimates

38. empirical analysis (3) Table 7: Difference-in-differences estimates of the employment impact of Maribel subsidies

39. empirical analysis (4) • the estimated coefficients are in line with the prediction that under standard assumptions about labor and product markets, Maribel subsidies increase full-time manual employment • The estimated effects are relatively large suggesting that Maribel subsidies created at least between 56 000 (0.060x20.66x22827x2 for 1999) and 85 000 (0.080x19.04x27644x2 for 1998) jobs or about 2 percent of economy wide employment. • But this is not to say that these effects would be accurate estimates if the government were to double the number of firms entitled to receive benefits since these are treatment-on- the-treated effects.

40. empirical analysis (5) Table 8: The impact of Maribel subsidies on alternative employment measures

41. empirical analysis (6) • Fixed-effects estimates reported above allow for unobserved time persistent firm characteristics such as time averaged firm size to be correlated with Maribel participation. • But if, for example, smaller firms are likely to grow faster, the estimated difference-in-differences presented above will be downward biased (given that smaller firms are less likely to receive Maribel subsidies). • A solution to this problem is to draw a sample from the group of non-receivers that better resembles the treatment group for example in terms of beginning-of-year full-time manual employment.

42. empirical analysis (7) Table 9: Matching estimates of the employment impact of Maribel subsidies

43. empirical analysis (8) • The analysis so far has used whether or not firms received Maribel subsidies as the explanatory variable (variation in Maribel subsidies at the extensive margin). • But receiving firms also differ in the amount of per-worker subsidy received in any given year (variation in Maribel subsidies at the intensive margin). • However, using the amount of Maribel subsidy as an explanatory variable introduces measurement error as was argued above. This will bias the estimated impact towards 0. • One possible solution to this problem is to apply a 2SLS estimator using the legal information as an instrument.

44. empirical analysis (9) • Consider the following second-stage equation of interest: (22) • To deal with measurement error in S and the possible endogeniety between S and N, consider the following first-stage: (23) where all right-hand-side variables are taken in 1997.

45. empirical analysis (10) Table 10: 2SLS estimates using the group of firms receiving Maribel subsidies in 1998 Notes: All regressions include a lagged dependent variable.

46. empirical analysis (11) • Under realistic assumptions about the nature of labor and product markets, Maribel subsidies are expected to increase full-time manual employment. • At the extensive margin, it was shown that firms receiving subsidies created more jobs compared to firms non-receivers using difference-in-differences and matching estimators indeed. • Also using variation at the intensive margin showed that among receivers the creation of low-skilled jobs is bigger the bigger is the subsidy.

47. empirical analysis (12) • Note that under standard assumptions about production technologies and product demand, the impact of Maribel subsidies is positive independent of who has the bargaining power: • It can also be shown that the impact of Maribel subsidies is expected to be bigger the more elastic is product and therefore labor demand.

48. empirical analysis (13) Figure 3: The employment impact of Maribel subsidies and union-bargaining power in manufacturing industries

49. empirical analysis (14) Figure 4: The employment impact of Maribel subsidies and import penetration in manufacturing industries

50. conclusions (1) • The question we started from was whether or not payroll tax subsidies are likely to increase wage flexibility and therefore employment? • We developed a framework to show that lump-sum employment subsidies are expected to increase employment under realistic assumptions about labor and product markets. • We used different sources of variation in firm level panel data exploited by different estimators to show that Maribel subsidies increased low-skilled manual employment by at least about 2 percent of the working population.