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Age and wage related versus across-the-board labour cost reducing policies

The distinction between the young and the elderly within low- and high-wage earning employment in HERMES, the FPB's medium-term macroeconomic model, enables the assessment of both age- and wage-related labour cost reduction policies.

The political debate on the employment of older workers in general and the emergence of age-related labour- cost cutting policies from both federal and regional governments in particular - either through cuts in employers' social-security contributions (SSCs) or wage subsidies - were an incentive to rethink the modelling of the labour market in HERMES, the FPB's medium-term macroeconomic model. The age structure of salaried employment in each branch of activity is embedded in a three-stage mechanism. First, aggregate demand and the relative cost of labour to capital determine salaried employment. Next, relative wages allocate employment among three major labour categories: low-paid jobs, high-paid jobs and special-employment programmes. Finally, within each labour category relative wages allocate employment between the young (aged less than fifty) and the elderly (aged fifty or more). Underlying this segmentation is the assumption that there are innate differences in skills and productivity across age and wage categories, causing imperfect substitution and warranting wage discrepancies.

Three policies that have gained prominence lately were looked into: employers' SSC cuts aimed at the low-wage end of the young, employers' SSC cuts aimed at the elderly and across-the-board wage subsidies to night-time Age and wage related versus across-the-board labour cost reducing policies work and work in shifts. These three policies are gauged against an across-the-board cut in employers' SSCs. Both a rigid and a flexible wage version of HERMES were used.

Cutting employers' social-security taxes on young low-wage earners generates more employment than any other social-security contributions cut or wage subsidy increase, in spite of job losses for the elderly and the young high-wage earners. The substititution effect favouring the low-wage segment causes the average wage cost to fall far beyond the initial labour cost cut. Because of this indirect effect, far more jobs are generated in the process than would have been the case otherwise.

SSC cuts targeting the eldery are at the expense of young low-wage employment. Because the elderly are more prominent in the high-wage than the low-wage category, elderly labour cost cutting policies result in bigger labour cost cuts for the high-wage earners than the low-wage earners. This explains why - apart from boosting both low-wage and high-wage elderly employment - young high-wage employment is stimulated as well.

Increasing the subsidy to low-wage and high-wage employment organised in work in shifts - in fact an across-the-board wage subsidy to manufacturing - yields less jobs but a higher increase in value added than an all-sector, across-the-board cut in employers' SSCs. The employment of all wage and age classes is stimulated alike, just as an across-the-board SSC cut would do.

In the flexible wage version of HERMES used in this study, real gross wages are affected by the unemployment rate and by labour productivity, but there is no direct impact of the tax wedge on wages. The Phillips curve effect - raising real gross wages - explains why the employment and value added effects of employers' SSC cuts are slightly less benign in the flexible wage regime of HERMES than in a wage regime that keeps domestic real gross wages in line with foreign wages in the baseline. In the case of the work-in-shifts subsidies, the Phillips curve effect on manufacturing gross wages is weakened by the sharp decline in manufacturing's labour productivity, causing a more favourable effect on exports and hence value added. In contrast, if the tax wedge did impact directly on wages, e.g. in a setting with right-to-manage wages, then lowering employers' SSCs or increasing wage subsidies would definitely raise the real gross wage, allowing the employees to appropriate some of the drop in the tax wedge.

Both work-in-shifts subsidies and low-wage SSC cuts are a drag on the government finances in the sense that only a small proportion of the initial budgetary cost is recovered, significantly smaller than in the case of across-the-board or elderly SSC cuts (13% and 18% versus 30%). In the case of low-wage SSC cuts, the proportion that is recovered is significantly higher in a flexible wage regime (30%) than in a rigid wage environment (13%), but is still below the budgetary outcome of the across-the-board policy in a flexible wage regime (38%). However, if gauged by the budgetary cost per additional job, targeting young low-wage labour is by far the cheapest option (EUR 51,000) whereas work-in-shifts subsidies are manifestly the most expensive policy (EUR 131,000 or EUR 151,000), whatever the wage regime.

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