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4 DISCUSSION

The results coming from both the theoretical and simulation models discussed in Sections 2 and 3 suggest that in principal there is scope for the government to improve the employment and output performance of the economy through the use of a balanced-budget tax and subsidy scheme. However, the models used to derive these results are extremely simple. On balance we believe that this simplicity is an advantage, although it is important to be aware of their limitations.

4.1 Perfect Competition

In the analysis reported above factor markets are taken to be perfectly competitive. This is clearly a gross simplification. It suggests that the appropriate time frame in which to locate the analysis is the long run: in the short run many frictions and imperfections will apply. This is an issue to which we shall return later. It also means that the subsidy schemes under consideration here are being set difficult hurdles to clear: if a subsidy can increase employment and welfare in a perfectly-competitive setting, it is likely to be even more effective in an imperfectly-competitive situation. This is certainly the finding in Jackman and Layard (1980)

However, a major question seems to arise with the adoption of a perfectly competitive labour market. This is that even if employment can be increased by employment subsidies, why should the government intervene? If individuals are choosing to be unemployed, why should the government attempt to influence that choice? A corollary of this is that it is sometimes argued that where the labour market is perfectly competitive, there will be no unemployment problem. But there are at least three arguments to support intervention under these circumstances. The first is that the usual explanation for voluntary unemployment is that the wage is not high enough to cover the opportunity cost of "leisure". However, in practice, "leisure" might involve operating in the informal or criminal sectors. Politicians might wish to subsidise jobs in the formal economy to counteract the expansion of these other sectors. The second point is that although the labour market is here perfectly competitive in terms of the determination of wage rates, there is already government intervention in the form of unemployment benefit. This is the argument put forward in Beacon and Monk (1987) and Jackman and Layard (1980). The payment of unemployment benefit distorts the market and labour subsidies are here known to generate potentially welfare improving outcomes. Third, there may be other externalities involved with unemployment, including ill health and family breakdown. At the very least these are likely to involve increased welfare expenditure.

4.2 Long-run Equilibrium

In specifying perfectly competitive factor markets and a complete absence of fixed factors in the production function, we are implicitly adopting a long-run perspective. That is to say, we are considering how a particular subsidy scheme will affect the long-run equilibrium of the economic system. This has one major drawback. We can say nothing about the particular path the economy will take in attaining the new equilibrium. In particular we say nothing about the speed of adjustment, but in so far as full adjustment here requires changes in the capital stock, this is likely to be a long drawn-our process. However, a strength of the analysis is that, independently of the particular short-run dynamics, the economy will be attracted systematically towards the new long-run equilibrium. In short, it would be fitting to regard the policies analysed here as appropriate to deal with long-run structural problems, rather than short-run adjustment difficulties.

4.3 Single Sector

Using a single-sector model greatly eases the general equilibrium analysis. It focuses attention on substitution between factors, which is the central mechanism at work, but neglects substitution amongst commodities. However, if a labour subsidy policy were to be implemented, the impact on individual commodities would be important and this might affect the political acceptability of such a scheme.

Consider the case used in the simulations of a fixed per capita labour subsidy, financed by an increase in VAT. This would increase the price of those commodities which use high wage labour, as against the price of commodities which are intensive in the use of low-wage labour. If this leads to substitution away from the higher priced commodities in consumption, the story told by the single-sector model is reinforced: not only is there a shift towards more labour intensive techniques but there is also a move to more labour intensive products. However, this might imply that there are some sectors of the economy which face large adjustments in total activity. Where this is a contraction, and especially where the industry is locationally concentrated, this might create political difficulties and some care would be required in timing the adjustment to the new equilibrium.

4.4 Closed Economy

The models investigated here are of a closed economy: there is no external trade. This has the advantage that any effects on economic activity and employment generated by the subsidy are not due to some form of implicit devaluation. It is not the case that the increase in employment is at the expense of employment in other countries with which the economy trades. The expansion in activity is therefore not vulnerable to retaliatory action from other countries.

However, the assumption of a closed economy is clearly unrealistic from the point of view of one of the members of the EU. Moreover, if we relax this assumption, and also the assumption of one single sector, such subsidies might attract considerable opposition in some traded sectors. For example, a capital intensive exporting sector would find itself less competitive in external markets. Similarly, a traded sector which extensively uses low-wage labour will be more competitive and this might generate complaints from trading partners. However, if the policy were to apply on an EU level, these sorts of problems would be minimised.

5 POLITICAL ISSUES

5.1 Public Expenditure

A major concern about automatic, general subsidies involves their impact on the total level of public expenditure. This has led to a questioning of the efficacy of subsidies in general and a move away from automatic general subsidies towards marginal and discretionary subsidies (HM Treasury, 1991; Swales, 1989 and 1995). There are three levels of defense for an automatic labour subsidy scheme of the form outlined here.

First, an informed discussion of the appropriate level of the public sector needs to distinguish between different types of government expenditure. The appropriate division between public and private provision of goods and services is a legitimate political concern. Moreover, one ought to be attentive to the possible adverse incentive effects generated by a heavy burden of welfare transfers on workers or shareholders. However, subsidies to aid the operation of the economic system do not fit into these categories. Such subsidies should improve, not impair, productive efficiency by offsetting market failure in other parts of the economy. They restore, rather than distort, appropriate price signals. They do not rob the private sector of resources but reallocate resources within that sector. And as we have seen, such subsidies generate an expansion, not contraction, of private sector economic activity. In principal, the absolute level of tax and subsidy flows associated with these balanced budget schemes should not worry the politician or civil servant, aside from low administration and compliance costs (Sandford et al, 1989).

All these points having been made, it clearly is the fact that governments are generally concerned about the overall level of taxation within the economy. However, the type of integrated subsidy and tax scheme that we investigate in the simulations could, in principle, be operated as a uniform tax scheme. That is to say, the change in the firm's tax bill could be calculated as the net difference between the additional VAT and the per capita subsidy. In so far as the scheme increased total employment, and thereby reduced payments of unemployment benefit, it would be associated with a reduction in the required overall tax take. That is to say, the introduction of the new tax scheme would increase employment and reduce taxation.

In the UK labour subsidies are very popular. Battu (1995) reports that 15 separate employment subsidy schemes have been introduced by the British government in the last 30 years. However these schemes have almost invariably been of a short-run marginal and/or discretionary type. Such subsidies might be an appropriate response to some short-run problem of employment adjustment or a reaction to perceived hysteretic effects in the labour market. But such schemes are costly to administer and potentially discriminate between aided and unaided firms. They are necessarily short-run in operation and are therefore not incorporated into the long-run decision making by firms (investment decisions, for example). It is difficult not to believe that one of the reasons why the UK government has favoured these marginal and discretionary approaches is the limited direct public expenditure cost associated with these policies. However, as we have observed, in so far as an automatic integrated tax scheme increases employment, total government expenditure will fall.

5.2 Distributional Issues

The impact of a subsidy/tax regime which changes the wedge between the consumption wage and the producer price of labour for different employment groups will have distributional consequences. In the simulations reported in Table 1 we notice that the employment impact is concentrated on lower income groups. In one sense this is a desirable outcome if one of the objectives of the policy is a relieving of economic inequality. However, there clearly maybe objections from higher waged workers. These might perceive their position as weakened because of their relatively adverse treatment by the combined tax and subsidy package. Indeed, in some simulations reported in Table 2 increased employment in low income groups occurs partly at the expense of lower employment and real wages for higher-wage sectors of the labour force. At the very least, policy makers should be aware of these possible distributional implications.

6 CONCLUSIONS

The results of the purely analytical and simulation results reviewed here is that the government can influence employment by introducing an appropriate tax and benefit system, even where the economy is working in a perfectly competitive way. It must be stressed that the analysis is of a long-run nature: that such policies would change the long-run equilibrium toward which the economy is being pulled. The analysis makes no predictions concerning the short-run dynamics, though some of the short-run implications have been identified here and in practice these might be politically problematic. There is at present an increased faith in "market forces" and a general desire to reduce subsidies that artificially maintain inefficient or inappropriate industries. However, where there are apparently high levels of structural unemployment amongst primarily low skilled workers, and where these unemployed are supported by welfare payments which lower the real income of workers and reduce their incentive to work, the possibility of long-term persistent labour subsidies should be considered. If such subsidies can be packaged as tax rebates the possibility occurs of a simultaneous fall in taxation and increase in employment.

REFERENCES

Battu, H. (1995), "A Computable General Equilibrium Analysis of Regional Labour Subsidies", Ph.D dissertation, University of Strathclyde.

Beacon, G. and Monk, P. (1987), "Employment Creation with Very Large Scale Labour Subsidies", Northern Economic Review, No. 15, Summer, 1987.

HM Treasury (1991), Economic Appraisal in Central Government: A Technical Guide for Government Departments, London, HMSO.

Jackman, R.A. and Layard P.R.G. (1980), "The Efficiency Case for Long-run Labour Market Policies", Economica, vol. 47, pp. 331-349.

Johnson, G.E. (1980), "The Theory of Labour Market Intervention", Economica, vol. 47, pp. 309-329.

Sandford, C., Godwin, M. and Hardwick, P. (1989) Administrative and Compliance Costs of Taxation, Fiscal Publications, Bath.

Swales, J.K. (1989), "Are Discretionary Regional Subsidies Cost-Effective?", Regional Studies, vol. 23, pp. 361-368.

Swales, J.K. (1995), "The Efficiency of Automatic and Discretionary Subsidies", Paper given to the Scottish Economists Conference,

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