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Labor Market Policy Instruments and the Role of Economic Turbulence

Philip Schuster ()

University of St. Gallen Department of Economics working paper series 2010 from Department of Economics, University of St. Gallen

Abstract: Times of high unemployment always inspire debates on the role of labor market policy and its optimal implementation. This paper uses a dynamic model of search unemployment and bilateral wage bargaining to characterize optimal labor market policy in a possibly turbulent environment. A firing externality, generated by the existence of a partial unemployment insurance system, distorts the pre-policy equilibrium along three margins: job creation, job acceptance, and job destruction. Optimal policy is characterized by a payroll tax, a firing tax, and a hiring subsidy. Endogenous job acceptance demands that a firing tax and a hiring subsidy have to be set equal in any case and cannot be used to correct for the possible failure of the Hosios condition. In that case the optimal policy mix has to be extended by either an output or recruitment tax/subsidy. It is further shown that the derived policy mix is robust to the introduction of economic turbulence in form of state-dependent worker transitions between skill classes. This is crucial as widely discussed intergroup redistribution schemes, like in-work benefits targeted at low-skilled workers, are rendered considerably less effective in that case. Instead of redistribution from high- to low-skilled workers or from firing firms to unemployed workers, the paper identifies a scheme involving redistribution from firing to hiring firms to be optimal.

Keywords: Search and matching; employment subsidies; economic turbulence; policy spill-over (search for similar items in EconPapers)
JEL-codes: E24 E61 J08 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2010-10
New Economics Papers: this item is included in nep-dge, nep-lab and nep-mac
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