Re: AltInst: Employment vs. Investment Subsidies

From: <>
Date: Fri Oct 16 1998 - 19:10:40 PDT

In a message dated 98-10-16 15:52:32 EDT, CLEMENS FUEST writes:

  "The governments of nearly all industrialised countries use
  subsidies to support the economic development of specific
  sectors or regions with high rates of unemployment. Conventional
  economic wisdom would suggest that the most efficient way to
  support these regions or sectors is to pay employment subsidies
  We present evidence showing that capital subsidies are
  empirically much more important than employment subsidies. We
  then discuss possible explanations for the dominance of
  investment subsidies and develop a simple model with
  unemployment to explain this phenomenon. In our model,
  unemployment arises due to bargaining between unions and
  heterogenous firms that differ with respect to their
  productivity. Union bargaining power raises wage costs and leads
  to a socially inefficient collapse of low productivity firms and
  a corresponding job loss. Union-firm bargaining also gives rise
  to underinvestment. In this framework, it turns out that an
  investment subsidy dominates an employment subsidy in terms of
  welfare. The reason is that investment subsidies are a more
  efficient instrument to alleviate the underinvestment problem
  and to raise the number of operating firms."

Unions can only raise wage costs where there is a surplus available in the
industry or firm due to monopoly or enhanced technological productivity, which
factors provide barriers to firm entry or displacement by foreign competition.
The failure of low productivity firms, subidized by cheap labor, is of little
consequence as their market share will be taken over by the more productive
firms, which will have a corresponding increase in employment. Of course, some
labor is released as the technical productivity is higher in the more capital
intensive unionized sector. This is of benefit to society in reducing the
number of workers it takes to make a commodity.

If unions lead to lower investment, then they are undermining the economic
basis for their own existence, which rests on enhanced technical productivity.

Investment subsidies can increase wage levels because employers would be able
to use more capital intesive methods and fewer better paid workers. At the
same time, there needs to be money for retraining of displaced workers.

Union bargaining success is more of a result than a cause of the market basis
for wage differentials. High productivity firms are likely to pay workers more
irrespective of unionization, or live up to industry wide negotiated
contracts. Non-unionized industries are more likely to rely on unskilled labor
and thus remain less likely to innovate.

Certainly, an investment subsidy for capital investment is to be preferred to
wage subsidies because it increases technical productivity. It is best
directed at the low capital firms. However, many non-unionized firms are
organized by the buyer, such as in textiles. They will always seek to
circumvent the more productive unionized shops. Bargaining, in the market as
well as by unions is an integral part of the economic process. Attempts to
show that bargaining is an exogenous economic variable always fail.

I would not recommend a general prescription for economic aid to a distressed
industry. Each has its own special circumstances. There are obviously
competing objectives of maximum employment and maximum productivity. One also
needs to consider the market structure, particularly in relation to exports
and imports.
Tom Lacey

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Received on Sat Oct 17 02:51:04 1998

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