Evaluation of the Australian Wage Subsidy Special Youth ...

9
employment effect could be mainly due to the scale effect. The size of the substitution
effects depends on the elasticity of demand for labour, both for subsidised and
unsubsidised labour. The scale effect size depends on the relative cost savings against the
total production costs. As a result, since these parameters remain unknown, the relative
size of the substitution and scale effects remain unknown, and so theory is ambiguous as
to whether the wage subsidy does act to increase employment.
Johnson (1980) presented the case of a subsidy to the disadvantaged, such as long-term
unemployed, youths without work experience, or the low-skilled. A key assumption is
rigid wages facing the unemployed, such as minimum wages, together with a fairly
inelastic labour supply. The model incorporates unemployment benefit payments, and
only the employed skilled workers pay taxes to cover the expenditures of the subsidy
program. Whether the skilled and unskilled workers are complementary or substitutes
influences the cost-benefits of the subsidy, as well as the replacement ratio. 3 Jackman and
Layard (1980), and Johnson and Layard (1986) found that if the supply elasticity for the
targeted subsidy group was higher than that for the taxed group, then there was a welfare
increase. However, the results are not unambiguous as the particular parameter values
assumed influence the outcome. If skilled workers and unskilled workers are
complements rather than substitutes, and unskilled labour is subsidised, there is a Pareto
improvement.
The following exposition draws on the description of the wage subsidy model by Dreze
and Sneessens (1997), but is based generally in the standard microeconomic framework.
They set up the model to allow for the labour market to involve a minimum wage, and to
involve market segmentation where low-skill labour operates in a different market facing
different wages. The wage subsidy is introduced for low-skilled labour only, and as such
is targeted. This model is appealing as it more closely approximates the situation of the
SYETP operation in Australia, with a minimum wage system and where the subsidy was
targeted to unemployed youths and was for low-level occupations only (For a full
description of the SYETP operation see Chapter 2 Australian Review).
3 The ratio of unemployment benefit to the wage rate.