Ebook Do wage subsidies affect the subsequent employment stability of permanent workers?: the case of Spain
Since the early 1990s, rising temporary employment rates in Spain have induced the regional and national government to implement a number of active labour market policies (ALMPs) designed to bolster the number of permanent hires and thus to forestall the perceived threat of temporary contracts over the country’s economic efficiency and equity.
Indeed, Spain invests more public funding in this type of ALMP than does any other OECD country. Between 1999 and 2002, for example, it dedicated roughly 0.28% of national output to this end. Yet between 1996 and 2006, the proportion of permanently employed Spanish workers rose by a mere 0.3 percentage points, from 66.4% in 1996 to 66.7% in 2006.
This paper focuses on labour market policies that use targeted subsidies to increase employment stability. Since 1997, when the national government issued an important labour market reform (see Kugler, Jimeno and Hernanz, 2003 and Mendez, 2008 for a description) many Spanish regional governments have offered one-time payments to firms issuing new permanent contracts to certain groups of workers. In our initial evaluation of this policy (García-Pérez and Rebollo, 2009), we concluded that the causal incidence of such subsidies over the entrance probability to a permanent contract was very low; specifically, our results indicated that while such subsidies increased by 67% the conversion of temporary to permanent contracts re-hired by same firm among eligible female workers between the ages of 30 and 45, it had no effect on other groups of temporary workers.
Moreover, the rise in this conversion rate among temporary workers (from 0.65% to 1.09%) was so small as to be economically irrelevant in terms of its final effect over permanent employment. We also obtained that the incidence of the subsidies over the pool of unemployed workers was only statistically significant among workers younger than 30, for whom the increase in the transition probability to a permanent contract for eligible workers ranged from 4% for female workers to 10% for male ones.
Despite this evidence, the available data on regional expenditure rates shows that such subsidies have been used intensively in some regions, where they represent a significant reduction in labour costs. In fact, cross-regionally, the joint availability of both national and regional subsidies can reduce the total labour costs of the average worker’s first two years of permanent contract by 11.8% for men aged 30 to 45, and by almost 22.8% for older female workers. It seems that regional subsidies affect total labour costs to a greater degree than do national ones. In fact, only between 3.6% and 10.4% of this cost reduction can be attributed to national payroll tax deductions.
The available literature indicates no overall positive effect of these ALMPs on the permanent employment rate. Katz (1994) shows that in a world marked by wage rigidities, the cost of labour drops when a firm receives a subsidy. If this cost reduction occurs during the worker’s term of employment the subsidy can, in fact, increase the duration of the job. However, if the subsidy consists of a one-time payment at the beginning of the contract its effects on employment duration are more uncertain. In a situation where labour costs increase with the duration of the contract, the relevance of any subsidy induced drop in labour costs diminishes as contract tenure increases. Hence, subsidized workers may in fact have shorter employment durations than other worker groups, particularly when the worker hired under a subsidized contract would not otherwise have been offered a position.
The idea is that wage subsidies counterbalance the lower labour productivity of eligible workers as compared against ineligible ones. In addition, the literature on causal evaluation points to a number of other unforeseen consequences of these policies. For instance, Calmfors (1994) argues that subsidizing permanent hires carries deadweight costs and substitution effects, which make it hard to evaluate the net effect of that strategy. Martin and Grub (2001) argue that most evaluations focusing on firm behaviour have pointed to large deadweight and substitution effects when private-sector employment is subsidized. As a result, such schemes yield small net employment gains. In a more recent paper, Mortensen and Pissarides (2001) show that wage subsidies might increase labour market rotation. Following this lead, one of the aims of this paper is to assess whether wage subsidies may favour the labour market rotation of eligible workers, by reducing the average duration of their permanent contracts. In broader terms, we wish to contribute to current knowledge regarding the effect of wage subsidies on employer hiring and firing practices.
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