Comparing the effectiveness of employment subsidies

This paper examines the implications of different types of employment subsidies for employment, welfare, and inequality. It investigates how these effects depend on what target groups the subsidies address. Our analysis focuses on policies that are “approximately welfare efficient” (AWE), i.e. policies that (a) improve employment and welfare, (b) do not raise earnings inequality and (c) are self-financing. We construct a microfounded, dynamic model of hiring and separations and calibrate it with German data. The calibration shows that hiring vouchers can be AWE, while low-wage subsidies are not AWE. Furthermore, hiring vouchers targeted at the long-term unemployed are more effective than those targeted at low-ability workers. [Display omitted] ► Microfounded model of hiring and firing with common labour market imperfections. ► Heterogeneous abilities and durations allow to compare different targeting schemes. ► Policy effectiveness evaluated by approximate welfare efficiency (AWE). ► AWE policies raise employment, welfare, do not raise inequality, are self-financing. ► Hiring vouchers can be AWE, while low-wage subsidies are not.