Times of high unemployment always inspire debates on the role of labor market policy and most of the time lead to a variety of policy advice. The motivation of this work stems from the on-going controversy about optimal policy instruments for Germany that experienced a dramatic increase in unemployment during the years 2000 to 2005. While people agree that especially the rate of low-skilled unemployment is excessively high and current policy is suboptimal and leaves room for improvement, opinions on what should be done are mostly at odds with each other. Take as an example debate the Sinn et al. (2006) versus Brown et al. (2007). While the former prefer wage subsidies targeted at persons with low abilities, the latter favor hiring subsidies for long-term unemployed workers with low skills. Other empirical studies suggest that the effectiveness of both subsidies is limited. Bonin et al. (2002) find that wage subsidies for low-skilled workers in order to decrease disincentives do not appear to work very effectively and that such a policy is likely to be too costly. Boockmann et al. (2007) draw their conclusions from legal changes in the eligibility of German workers to EGZ which they use as natural experiments. They find that eligibility to this subsidy did not change the transition rates from unemployment to employment significantly. However, named empirical studies provide limited conclusion concerning the macroeconomic effects of hiring and wage subsidies as they cannot directly measure the effect of the subsidies in question, because they have never been implemented Germany-wide.

Cahuc and Le Barbanchon (2010), in their study on counseling, very well notice that micro evaluations neglecting crowding out, adverse spill over effects on non-targeted persons, and other equilibrium effects can lead to misguided policy advice. A similar point is made by Van der Linden (2005) who endogenizes job search effort and wages in his evaluation. In addition, the sort of studies mentioned above tends to lack a thorough evaluation of the cost side. Therefore, we base our analysis on a model of equilibrium unemployment and our conclusions rely on theoretical reasoning and numerical simulations.