Evaluation of the Australian Wage Subsidy Special Youth ...

10
The labour market for low-skill labour is shown in Figure 1.1. Labour demand is LD,
while Labour supply is LS, which in a competitive market might give the wage and
employment outcome at A (w*, L*). The minimum wage is set to w + , which gives a
market outcome for the demand for labour at B, with employment at L + . The effective
labour supply corresponds to D, with unemployment the difference (L # -L + ). By offering a
wage subsidy to employers of the amount, (w + -w*), the firms raise their labour demand
to LD2. The outcome is then drawn to point E with the wage w + equivalent to the
minimum wage and employment L*. Unemployment is reduced and employment is
raised.
Dreze and Sneessens (1997) elaborate the model by describing a ‘ladder effect’ linking
the skilled and unskilled labour markets, whereby if higher skilled wages lead to lower
employment at the next higher skill level then the unemployed from the skilled market
can become part of the labour supply in the low-skilled market. The labour demand then
has skill-substitution effects, where unskilled wages are relative to other wages. Wage
subsidy programs can then raise the employment of the person, simply by reducing the
costs to an employer of hiring that particular person.
Katz (1996) p7 also discusses the partial equilibrium dynamics of wage subsidies in this
type of model shown in Figure 1.1. In the Katz model, the labour market is for low wage
rather than low skill workers. This is also true for the Phelps (1994, 1997) subsidy. Katz
additionally considers an infinitely elastic effective supply of labour, such as when there
is structural unemployment, which would make the LS curve in Figure 1.1 horizontal. In
this case, the wage subsidy does not affect wages but expands employment in proportion
to the elasticity of labour demand for the low-skill (or low wage) workers. The effective
wage elasticities of both labour demand and supply are key to the effects of the subsidy.
However Katz (1996) also points out that in practice, design issues, administration,
employer take-up, can all affect the practical effect of the subsidy.