EVALUATING ALTERNATIVE JOB CREATION STRATEGIES

EVALUATING ALTERNATIVE JOB CR EAT1 ON STRATEG I ES

LAURIE J. BASSI'

This paper examines the costs of iob creation under a wide range o f programs that the government has at its disposal. The framework chosen for the analysis is a standard neo-classical model which allows for pockets o f unemployment (created by structural imperfections in the operation of the labor market) but not cyclical unemployment. A general conclusion that emerges from the analysis is that job creation programs which are tightly targeted at disadvantaged workers (the structurally unemployed) are much less costly methods of creating additional employment than are untargeted programs.

During the 1970s federally funded job creation programs played a major role in the operation of the U.S. labor market. Under the Reagan adminis- tration however, these programs experienced drastic cuts in funding-particularly in the public sector. These dramatic policy changes were caused at least in part by a general disillusionment with the ability of government to create additional employment at a reasonable cost.

Now that the dust has settled, it seems clear that this disillusionment was created by a confusion between the role of government in combating cyclical unemployment as opposed to structural unemployment. When counter- cyclical direct job creation programs are used in an attempt to alleviate structural unemployment (as was the case in the 1970s), it is not surprising that the programs appear to be ineffective.

In the process of eliminating these programs, we are in danger of throw- ing out the baby with the bath water. Structural unemployment is still with us and, if anything, can be expected to worsen in the next decade with increasingly rapid technological change. This paper examines the costs of job creation under a wide range of programs that the government has at its disposal. The framework chosen for the analysis is a standard neo-classical model which allows for pockets of unemployment (created by structural imperfections in the operation of the labor market) but not cyclical unemployment.

A general conclusion that emerges from the analysis is that job creation programs which are tightly targeted at disadvantaged workers (the struc-

*Georgetown University. This research was generously supported by grants from the National Commission for Employment Policy and the Sloan Foundation to the Urban Institute. The opinions expressed herein are those of the author and do not necessarily represent the official position of the Commission, the Sloan Foundation, or the Urban Institute. The author would like to thank J. Bishop, R. Ehrenberg, A. Long, S. Sandell and I. Sawhill, two anonymous referees, and the editor for helpful comments. Special thanks are due to L. Burbridge for assistance in the preparation of this paper.

671 Economic Inquiry Vol. XXIII. October 1985

672 ECONOMIC INQLURY

turally unemployed) are much less costly methods of creating additional employment than are untargeted programs (which are generally counter- cyclical in nature), While this result is not too surprising given that it is generated by a neo-classical model, the analysis does give us a consistent method for considering the most cost-effective means of combating unemployment that is generated from structural imperfections.

The analysis is, of course, not without its qualifications. Perhaps the most obvious is that the framework used here allows only for an examination of the costs of a variety of job creation strategies without any consideration of differential benefits that may accrue to participants (and society) under alternative programs. A second major caveat is that the programs that pro- vide the most cost-effective method for job creation are, unfortunately, also the most burdensome from an administrative point of view. These, as well as other policy implications, are discussed in more detail in the final section of the paper.

The outline of the paper is as follows. Section I provides a description of the range of job creation strategies that are available to the government and briefly reviews the U.S. experience with each of these strategies. The next section outlines a consistent theoretical framework for estimating the costs of creating an additional job under each of these strategies. Section I11 develops the actual estimates of costs, and the final section presents the conclusions and policy implications.

I. ALTERNATIVE JOB CREATION STRATEGIES

At the broadest level, job creation strategies can be divided into one of two categories: block grants and wage subsidies. Block grants are a direct transfer from the federal government to either a state or local government, or a private firm. These grants may or may not be accompanied by a restriction that the grant be spent entirely for hiring additional workers, as opposed to hiring additional units of other factors of production. Further restrictions on the type of worker hired (for instance, economically disadvantaged youth) can also be placed on the grant.

In a traditional economic framework, an unrestricted block grant will generate a pure output effect. If we divide factor inputs broadly into labor and “all other inputs”, a block grant can be thought of as simply a parallel shift in the isocost line (see Figure 1). In other words, for any given level of costs, the firm (or government) can now produce a higher level of output.

In the absence of any restrictions on how the grant may be spent, the resultant increase in employment will be determined solely by the “budget elasticity of demand for labor (see section I1 for more detail on this point). If, however, the grant requires that the funds by spent only on additional employment (and these restrictions are followed) the output expansion path is restricted to be a hor‘izontal line through the initial input combination point. Further restrictions can be placed on the grant by limiting the increase in employment to a particular category of labor.

BASSI: JOB CREATION STRATEGIES

All Other Inputs

673

I ‘

r! Output expansion path without restriction

+ Output expansion with restriction

it expansion path

Labor

FIGURE 1 The Case of Block Grants

Wage subsidy schemes are the other major category of job creation programs. A wage subsidy reduces the effective wage rate that must be paid to workers, thereby affecting the slope of the isocost line (see Figure 2). Conse- quently, wage subsidies generate output effects (a movement between iso- quants) as well as substitution effects (a movement along a given isoquant).

A”other Inputs I

Labor

FIGURE 2 A General Wage Subsidy

The wage subsidy depicted above is a “general” wage subsidy. That is to say, all workers are eligible for it. It is also possible to have “marginal” wage subsidies. These subsidies are paid only for workers hired above the base level of employment (see Figure 3).l As was the case with block grants, wage subsidies can be accompanied by additional restrictions which limit them to a particular category of labor.

1. The base could be defined more generally as KE, where K is some constant and E is the initial level of employment. In Figure 3, I have restricted K to be equal to one.

674 ECONOMIC INQUIRY

All Other Inputs

Labor

FIGURE 3 A Marginal Wage Subsidy

Wage subsidies have been used only on a very limited scale here in the United States.2 They have always been marginal wage subsidies, targeted at particular groups of disadvantaged workers. They have been available only in the private sector in the form of an employment tax credit. There is no reason, however, why wage subsidies could not be used in the public sector as well.3

Block grants have been used exclusively in the public ~ e c t o r . ~ They have been both restricted and unrestricted. The restricted block grants (typically referred to as public employment programs) have almost always been targeted on particular categories of disadvantaged labor. The degree of target- ing, however, has varied considerably. During the 1970s, public employment programs became more and more tightly targeted on the most disadvantaged members of the work force.

I t . THE THEORETICAL FRAMEWORK

Conventional analysis of the firm will be used to develop analytic expres- sions for the employment effects of each of the programs outlined above.5 The units of analysis in the private and public sectors are, respectively, the firm and local governments. The objective function of both firms and local governments is assumed to be cost minimization subject to an output constraint. In the case of the firm, this objective is entirely consistent with profit

2. They are, however, used more extensively in European countries. 3. Obviously, public sector wage subsidies would have to use some reimbursement scheme

other than the tax system. 4. It is unlikely that block grants would ever be used in the private sector since this would

result in large windfall profits to employers. 5. Some of the results derived here are similar to the earlier results of Johnson and Tornola

(1977). The model used here, however, is more general than the one used by Johnson and Tomola.

BASSI: JOB CREATION STRATEGIES 675

maximization, provided that the output level has been chosen so as to equate the marginal revenue and marginal costs of the firm. In the case of local governments, the output level can be regarded as being bureaucratically imposed.s

The model will be developed with the objective of making the analysis empirically tractable. This requires the imposition of assumptions which restrict the approach to a partial equilibrium analysis. Specifically, it is assumed that there are constant returns to scale and that prices in unsubsidized sectors or industries are unaffected by the programs.

The objective function of either the firm or local government is summarized as follows:

Minimize: B = c W, Li

Subject To: 9 = f ( Li)

where: B = cost (budget) constraint W, = wage (or rental) rate of input i Li = amount of input i, ( i = 1, . . . , n ) q = quantity of goods and services produced f = production function.

i=l

By setting up the Lagrangean, we can solve for the demand functions in the usual way.

(1) Li = Li (9, Wl, . ' 7 W")

Differentiating (1) totally gives

(2)

Using the fact that dx = xdlnx, (2) can be rewritten as

rl

dLi = (aL,/aq)dq + C(aLi /awi)dwi . i=l

(3 ) n

where the 7's all represent elasticities. Equation (3) will serve as the basis for our analysis of wage subsidies. In order to analyze block grants, it is helpful to employ duality theory to reformulate (3) as

dlnLi = qr,i,dlnB + $qr.ilvidlnWi. i= I

(4)

The Employment Effects of Block Grunts Block grants are an exogenous increase in income that shifts cost con-

6. An alternative approach would be to assume that the decisions of the local government represent the median voter (e.g., Ehrenberg 1972). This approach, however, would not significantly affect the final outcome of the analysis.


straints. The prices of factor inputs (Wi) are assumed to be unaffected by block grants.’ Since dlnW, = 0, equation (4) reduces to

(5)

To make the analysis more concrete, we assume three factor inputs: low skill labor (Ll), high-skill labor (Lp), and capital (K). The general level of employment is L, where t = L , + Lp. The level of block grant funding is C.8 The change in the general level of employment resulting from an unrestricted block grant is then

dlnL, = q L , B - dlnB.

(6) dL = (q,,BGL)/B.

The employment changes by skill category are similarly determined by the wage elasticity of demand for each group.

By imposing “maintenance of effort restrictions,” that require the entire grant to be spent on additional employment, block grants can be turned into employment grantsg The general employment effects of these restricted block grants are (7) dL = {6/w 4- [(1-6)qL&]/B)G where 0 5 6 51. The parameter 6 measures the extent to which the maintenance of effort restrictions are followed, and W is the average wage rate.l0 The extent to which these restrictions are not followed is known as “fiscal substitution”, and is equal to (1 - a).” Intuitively, equation (8) says that the additional resources available due to fiscal substitution will be spent in the same way as would unrestricted funds from block grants. Note that if the restrictions are met perfectly (6 = l), then the change in employment is simply G/W. If the restrictions are not followed at all (6 = 0), then the employment effect of employment grants is equal to the effect of unrestricted block grants.

Employment grants have the advantage that by putting additional restrictions on how the grant is spent, the employment effects can be concentrated on a particular category of labor. The employment effects of a targeted employment grant, where L , is the “target group,” are:

(8) dL, = (6’/w + [(1-6‘)qL,BL,]/B]C; dLp = [ (1 -6’) 7 L2B L p G] /B;

7. This, of course, implies a totally elastic labor supply. This is obviously an unreasonable assumption in the case of untargeted programs and will result in an underestimate of the costs of job creation via these means.

8. In other words, dB = C. This is an assumption of the partial equilibrium analysis. In a general equilibrium analysis, we would allow for budgets to be affected by grants, dB = (aB/ac)G.

9. The Public Service Employment Program (PSE) would exemplify this type of grant. 10. In the absence of some type of policing of these restrictions, we would not expect them

to be followed since the firm or local government can always benefit from fewer restrictions. The term fiscal substitution refers to the extent to which state and local governments use grants from the federal government to finance expenditures that would have been financed internally in the absence of the federal grant.

11. It is not possible to directly estimate (1 - 6). The estimates of ’fiscal substitution” available in the literature are actually a measure of ((6/W + [(l - 6)qLeL]/B).


where 6‘ measures the extent to which the maintenance of effort restrictions are followed under the targeted program.12 As with an untargeted grant, the employment effect for group L, will be G/WI if the restrictions are met perfectly. Part of the money that is not spent on additional employment of L,, (1 - 6’)G, will be spent on additional employment of L,. The extent to which this happens is determined by q I , 2 B , the budget elasticity of demand for L,. The Employment Effects of Wage Subsidies

The employment effects of a wage subsidy are more complicated than those of block grants. First, along a given isoquant, a subsidy will cause a substitution away from the unsubsidized input into the subsidized input (a movement from A to B in Figure 4). Secondly, a subsidy will lower the output price in the sector or industry that is receiving the subsidy, thereby inducing an output effect (a movement from B to C in Figure 4). We con- sider both of these effects in turn.

All Other Inputs

Labor

FIGURE 4 The Employment Effect of Wage Subsidies

The first effect (movement along an isoquant) can be measured by the elasticities of substitution. The elasticity of substitution between any two factor inputs is defined as:

(9) After some manipulation it can be shown that:

uH = --dln(Li/Lj) / dln(W,/Wi) I dq = 0.

(10) r) LiWi = 0 LiLi t i ;

(11) rl LiWi = 0 LiL, * t i ;

12. A separate fiscal substitution rate has been allowed for under the targeted program (1-6’) since there has been some speculation that 1-6’ < 1-6. The maintenance of effort restrictions in the case of a targeted grant would be that the grant be used to expand the employment of L , beyond what it would otherwise be.

Footnote 12 continued on next page

678 ECONOMIC INQllIRY

where ti = WiLi/B is input i's share of total cost. Equations (10) and (11) show that, if we know (1) the extent to which each input contributes to total cost (ti), and (2) wage elasticities (either own or cross), we can then calculate elasticities of substitution, u. This parameter, in turn, tells us the extent to which a subsidized factor will be substituted for an unsubsidized factor.

In addition to the substitution effects embodied in (10) and (ll), there is also an output effect. To quantify this effect, we first need to specify a demand function for goods in the subsidized sector as

( 12) 9 = 9(P, P I , Y-T) where:

p = price per unit of goods in the subsidized sector p, = price per unit of goods in the unsubsidized sector Y = total income T = taxes paid to the federal government.

Totally differentiating (12) and rewriting it in elasticity form leaved3

(13) where qqp is the price elasticity of demand for output. The factor price frontier may be written asI4

d l n p = x t i . dlnW,. (14)

We will assume that the first input is to be subsidized. So be setting d In Wi = 0 for i = 1, and substituting (14) into (13), we have

( 15) dlnq = q,,,t,,dlnW.

We now return to equation (3). Rewriting it as15

(16)

and substituting (15) into (16), we have

(17)

The effect of a general wage subsidy on the general level of employment is then

(18)

dlnq = q,,, * dlnp

rl

i=l

dlnL = dl119 + q,,,"dlnW

d l n , = qu,t,dlnW + q,,wdlnW.

dL = (t7,,,tr. + V,.W)SLN

Footnote 12 continued It is conceivable that 6' > 1. This could be the case if the program created a multiplier effect

for L1 workers. In this case dL2 < 0. This would be consistent with a very large, positive elasticity of substitution between L , workers.

13. Assuming d p , = dY = dT = 0. These assumptions are necessary to keep the analysis empirically manageable, but would need to be relaxed in a general equilibrium analysis.

14. This assumes constant returns to scale, implying that marginal cost = average cost = price.

15. Here we have used the assumption of constant returns to scale which implies that 7 ,,,, = 1.


where S is the (dollar) subsidy level.l6 The first term measures the output effect, and the second embodies the substitution effect along a given i~0quant.l~

The employment effects of a general wage subsidy targeted at L, are

119) dL, = (9ypt,<, + %,lw, )sLJwl and

dL2 = ( V y p + %,,,)t,,,SL2/W*. The employment effects of marginal wage subsidies are calculated in a

similar fashion. Instead of the subsidy being available for all labor (or a specific category of labor), it is only available for (1-a) percent of those workers, where a is the percent of the work force that IS not subsidized.ls The general employment effects of a marginal subsidy are then simply equal to

(Wt dL = “l--a)’f,,t , + q,,wlSL/W. The substitution effect, measured by q, ,MSL/W, is the same for both marginal and general subsidies. The two programs’ results differ only through different output effects. If none of the regular work force is subsidized, a = 1, then there is no output effect. The smaller the value of a, the closer are the ouput effects of marginal and general subsidies.

If the marginal subsidy is targeted at L , , the employment effects are

(21) dL, = [(l--a)rlqpt,,, + T l / . l M ‘ l l and dL2 = [(l--cu)~q, + %,l , , l~~, ,SL*/W2.

A difficulty in using equations (18)-(21) is that t)y,, the price elasticity of demand for output, is difficult or impossible to measure (particularly in the public sector). In developing our estimates of net costs of job creation, we are forced to use a “reasonable” value for qyp. Fortunately, the estimates are quite insensitive to the value chosen for qq,, since so little of the labor force is subsidized.lg

Costs of Net Job Creation The cost of net job creation under any of these programs is simply the

total cost of the program divided by the number of new jobs created. In the case of block grants (either restricted or unrestricted), the cost of the program is simply G . In the case of wage subsidies, the cost of the program is S [ (1 -a )L + dL] , where S is the subsidy level, a is the base level of employment above which the subsidy is paid, L is the number of regular workers, and dL is the number of additional workers hired in response to the subsidy. In Table 1, these program costs have been combined with formulas for estimating the number of new jobs created under each program.

16. Note, S < 0. 17. This follows from equation (11) since the own-wage elasticity implicitly embodies the

substitution effect . 18. For instance, an often discussed value for (I is (I = L,- ,/I,,. In period t , the subsidy

would only be available for those workers hired above the level of employment in period t - 1. 19. In other words, (I is close to 1 and the resultant output effects are small.

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TABLE 1 - Continued

Summary of Notation

total employment employment of low-skill labor employment of high-skill labor average wage rate wage rate of low-skill labor wage rate of high-skill labor size of block grant total budget to local government (or firm) level of wage subsidy (in dollars) level of employment above which marginal subsidy is paid fiscal substitution rate under untargeted program fiscal substitution rate under targeted program quantity of output in subsidized sector price of output in subsidized sector budget elasticity demand for labor price elasticity of demand for output wage elasticity of demand for labor elasticity of substitution between high- and low-skill labor labor’s share of total budget = W L / B low skill labor’s share of total budget = W, L , / B

Documentation of Formula Derivation

Equations estimating dL: Block Grants = Equation (6) Untargeted Employment Grants = Equation (7) Untargeted General Wage Subsidies = Equation (18) Untargeted Marginal Wage Subsidies = Equation (20)

Equations estimating dLI and dL,: Targeted Employment Grants = Equation (8) Targeted General Wage Subsidies = Equation (19) Targeted Marginal Wage Subsidies = Equation (21)

Block or Employment Grants = C Llntargeted Subsidies = [ (1 -a) L + dL] S Targeted Subsidies = [ (1 -a) L , + dLl)S (Note that for general subsidies, a = 0) .

Costs of Programs:

111. ESTIMATES OF THE COST OF JOB CREATION

We have now seen that fiscal substitution is the key parameter determining the cost of job creation under employment grants, while the budget elasticity, the wage elasticity, and the elasticity of substitution are the key parameters for wage subsidies. In this section we first sumniarize the empirical


literature on each of these key parameters, and then derive a set of cost estimates based on these estimates.

Estimates of Fiscal Substitution The particular type of fiscal substitution with which we are concerned is

the extent to which funds from federally funded employment programs have been used to finance “regular” employment expenditures by state and local governments. The results summarized here are based on our experience with the public service employment program (PSE) of the Compre- hensive Employment and Training Act of 1973 (CETA).

Estimation of the fiscal substitution rate under PSE is complicated by the fact that the program periodically underwent major changes. The first changes, which took place in 1976, were designed to limit eligibility for PSE to the economically disadvantaged. To the extent that fiscal substitution is less under more tightly targeted programs, we would expect the fiscal substitution rate under PSE to fall over time. On the other hand, as local governments adjust their employment levels to account for the extra employees provided by PSE, we would expect fiscal substitution to rise over time.

We will refer to the program prior to 1977 as “untargeted PSE,” and the program after 1978 as “targeted PSE.” The period from 1977-1978 repre- sented a “transition” period from the untargeted to the targeted PSE.20 A number of studies have attempted to measure the fiscal substitution rate during each of these periods. Because of differences in methodologies, some of these estimates correspond to short-run estimates, while others are annual- ized (one year) estimates or long-run estimates (more than one year). Table 2 presents the range of available estimates. The pattern that emerges from these estimates is that in the short-run fiscal substitution was very low but rose over time. Under the untargeted version of PSE, the long-run fiscal substitution rate was probably not significantly different from one. Under the tightly targeted version of PSE, the long-run fiscal substitution rate is estimated to be between 0 and 29 percent.

There are, no doubt, a variety of factors that determine the rate of fiscal substitution. Likely candidates include the state of the economy, the political environment, the level of funding, as well as the restrictions accompanying the use of the funds. So to attribute the decline in the fiscal substitution rate to the restructuring of the program is to implicitly assume that fiscal substitution was unaffected by changes in these other factors.

The Budget Elasticity Our experience with block grants has been limited to the public sector.

Consequently, in developing an estimate of the impact of unrestricted fed-

20. This assumes that the effects of the reauthorization were not immediate but occurred in the year following the legislative change. A Congressional Budget Office (1981) report shows that PSE did not really become more tightly targeted until after the legislative changes in 1978. During 1977-1978, the program was only slightly more targeted than it was in 1976.


TABLE 2 Estimated Fiscal Substitution Rate by

Duration of Funding (percent)

Less than a Year One Year More than a Year

Untargeted PSE' (1974-1976) 0 50-60 100

Transition PSE (1977-1978) 18-21 36 23-70

Targeted PSE (1979) 14 NA 0-29 a. These estimates are based on studies by Johnson and Tomola (1977) and Bassi and Fech- _ _

ter (1979). b. The short-run estimates are from studies by Cook (1980) and Nathan (l979), the inter-

mediate estimates are from Bassi and Fechter (1979), and the long-run estimates are from Adams (1981) and Bassi (1981).

c. The short-run estimates are from Cook (1980) and the long-run estimates are from Adams (1981) and Bassi (1981).

era1 grants on employment, we have confined ourselves to the public sector. Unfortunately, there is not a great deal of evidence on the budget elasticity, and the available estimates differ widely. The range used in developing the cost estimates at the end of this section was .12-.50.21

The Wage Elusticity There is, however, a much more extensive literature estimating wage elas-

ticities for both the private and the public sector. In an extensive review of the literature estimating wage elasticities in the private sector, Hamermesh (1976) isolates a range of elasticities from -.05 to -35, with -.15 being what he considers to be a reasonable medium wage elasticity in the private sector.22 This range is for short-run (four quarter) elasticities, but the long- run elasticities that were derived generally fit into this range.

Clark and Freeman (1980) argue that the articles reviewed by Hamermesh underestimate wage elasticities. Their short-run estimate of the wage elasticity is -.29, and their long-run estimate is -.50. However, their short-run estimate still falls within the range given by Hamermesh.

Wage elasticities calculated for the public sector are larger than those found in the private sector. Ashenfelter and Ehrenberg (1975) find a short- run estimate of -.70. Johnson and Tomola (1977) have an estimate of -.56.

21. The lower estimate of .12 can be found in Ashenfelter (1978). The higher estimate was developed by Bassi (1981). Other estimates produced by Gramlich ( M E ) , and by Johnson and Tomola (1977) are closer to the upper bound of this range.

22. This range excludes studies that do not hold the cost of capital constant and is further limited to studies done from 1962-1974.


Ashenfelter (1978) comes up with a best estimate of -.53.23 However, the low estimate in the public sector (-.53) is not statistically significantly different from the high estimate in the private sector (-.35), indicating that there is significant overlap in the two sets of estimates. Consequently, the entire range of estimated wage elasticities, from -.15 to -.70, has been used in developing cost estimates.

The Elasticity of Substitution For elasticities of substitution in the private sector, we use Hamermesh

(1976) and Hamermesh and Grant (1979). The literature which they review includes both time-series and cross-sectional studies. Unfortunately, this literature is diverse so it is difficult to come up with a reasonable range of estimates. We selected only studies we felt were most relevant to our needs.

First we used only studies which estimate substitutability between low- skill and high-skill labor. Second, we eliminated studies that did not control for the cost of capital. Finally, we did not include studies which didn’t con- sider the price of inputs to be exogenous. Given these considerations, we found u between low-skill and high-skill labor roughly between .50 and 2.0.

Bishop and MacDonald (1977) estimated elasticities of substitution for the public sector. They develop a skill index using 3-digit census occupations and derive elasticities of substitution between categories of labor that they have designated as being of high, low, and medium skill, for state and local governments separately. These elasticities generally range from .70 to 1.5.24 Since this is consistent with the range found for the private sector, we have maintained the same range-.SO to 2.0-for both sectors.

Table 3 summarizes the range of estimates we use in calculating high and low estimates of the net costs of wage subsidy programs. These estimates, along with the estimated rates of fiscal substitution that were summarized in Table 2, are the critical parameters determining the cost of net job creation. The wide range in the estimated costs reflects the wide range of estimates of the key parameters.

TABLE 3 Estimates of Elasticities

Low High

Budget Elasticity (Public sector only) Wage Elasticity Elasticity of Substitution

.14 -.15

.50

.50 -.70 2.00

23. He has three estimates in this paper. But the estimates he obtains using ordinary least squares are implausibly low. The estimate given above was obtained using two stage least squares.

24. We discarded as implausible two very small negative numbers that fell outside this range.


Cost Estimates of lob Creation The data used in deriving the cost estimates are presented in the Appen-

dix. Because the ranges for the elasticities are large, we present both high and low cost estimates. Generally speaking, the higher the wage elasticity, the lower the estimated cost.

We used the same wage elasticities when formulating cost estimates for low-skill labor as we did for labor in general. However, some evidence from Hamermesh and Grant (1979) implies that low-skill workers have higher wage elasticities. This would conform with the conventional belief that lower skilled workers are more easily laid off than highly skilled workers. Therefore, the low cost estimates (based on high wage elasticities) are probably more accurate than high cost estimates. The level of subsidy under the wage subsidy programs was assumed to be 25 percent of the minimum wage. This amounts to an annual rate of $1320 in 1978.

The data used in deriving these figures were for 1978, the most recent year that data were available for all the variables we used in the estimation. Therefore, in looking through these figures one should keep in mind that inflation will make them higher now.

Table 4 contains our estimates of net job creation for each of the programs discussed here. These estimates are the cost per each additional worker hired as a result of the program.% For the targeted programs, costs are estimated per additional worker in general as well as for low-skill workers.2*

The range of estimates in Table 4 is very broad; the precise estimates should not be taken seriously. However, the lessons that can be learned from this table are not from the specific estimates themselves, but rather from the ranking of the estimates. A quick glance at the table reveals that it is relatively inexpensive to create jobs using either marginal subsidies or targeted employment grants. Job creation under general wage subsidies or untargeted employment grants is very expensive.

This rank ordering of costs depends upon several key assumptions. As- sumption (1): Marginal wage subsidies are only available for workers hired in excess of 90 percent of the base period employment level. The costs of job creation under marginal wage subsidies will approach the costs under general wage subsidies as this percentage is reduced towards zero. Assump- tion (2): The elasticity of demand for output in the subsidized sector or industry is equal to one. If the true elasticity is less than one, job creation under wage subsidies will be more expensive than is estimated here. This is particularly true for general wage subsidies. If, however, the true elasticity is greater than one, the estimated costs of job creation will be overstated.

25. Since we did not have budget elasticity estimates for the private sector (and since it is highly unlikely that this approach would be used in the private sector anyway), costs for block grant and employment grant programs are estimated for only the public sector.

28. We designated as low-skill those full-time, full-year workers whose annual incomes would put their average hourly earnings at or below the minimum wage (about 18 percent of the total full-time, full-year workers).


TABLE 4 Cost Estimates of Net Job Creation by Program Type

Public Sector Programs Average Cost Average Cost Per

Per Job Low Skill Job

Block Grants 44,486-186,917 - Untargeted Employment Grantsa 29,920-37,400 - Targeted Employment Grants 5,300-7,188 5,300-7,465

Average Cost Average Cost Per Public or Private Sector Programs Per Job Low Skill Job

Untargeted General Wage Subsidies 11,840-18,476 - Targeted General Wage Subsidies 9,229-24,329 a,425-28,361 Untargeted Marginal Wage Subsidies 3,257-8,059 - Targeted Marginal W’age Subsidies 2,198-5,708 2,073-4,748

a. Based on a fiscal substitution rate of 50-60 percent. b. Based on a fiscal substitution rate of 0-29 percent. c. Based on a subsidy of 25 percent of the minimum wage. Marginal wage subsidies are

assumed to be paid for workers hired in excess of 90 percent of the base period employment level.

Assumption (3): “Fiscal substitution” is lower under targeted employment grants than under untargeted grants.

These results have been derived by assuming that the supply of labor is perfectly elastic-that is to say that all expenditures go to creating additional employment, rather than increasing wage levels. While this may not be an unrealistic assumption for targeted programs, it is clearly not the case for untargeted programs. This indicates that the estimates in Table 4 have underestimated the cost of untargeted job creation. This reinforces the prin- cipal conclusion-untargeted job creation programs are very expensive.

IV. CONCLUSIONS

These cost estimates indicate that of all the job creation programs con- sidered here, the lowest budgetary costs are incurred under marginal wage subsidy programs, targeted at low-skill workers. In the past these programs have been used in the private sector in the form of tax credits. However, there is no reason why marginal targeted subsidies could not be used in the public sector, where the program could be run through a voucher system.

One should keep in mind, however, that while marginal wage subsidies are less expensive, they are the most cumbersome to administrate. To be effective, these programs must be designed to ease the paperwork required of employers. Otherwise, employers will simply refuse to participate, thereby

w ECONOMIC INQUIRY

reducing the number of new jobs created. Our limited experience with private sector wage subsidy programs has, indeed, been met with remarkably low employer participation rates. Similar programs have, however, been used in Europe with much more success.

Another inexpensive method of job creation is highly targeted employment grants. Since employment grants are essentially a wage subsidy program where 100 percent of workers’ wages are subsidized, it is a more expensive form of job creation than marginal wage subsidies that subsidize only a fraction of workers’ wages. However, our recent experience with the public service employment program (PSE) indicates that when the program is tightly targeted at low-skill workers, as it was after 1978, the net cost of job creation is very low.

If the program is not highly targeted, as was the case prior to 1978, job creation by this method is very expensive. The previous section indicated we probably underestimated the costs of untargeted programs. This implies that the cost of job creation may be prohibitively expensive if programs are not tightly targeted.

Unfortunately, the estimated budgetary costs presented in this paper pro- vide only one of several pieces of information that would be necessary to choose the most cost-effective program for disadvantaged workers. In addition to the costs which we have estimated, we would also need to have information on the administrative costs of each of the available programs, their output effects, and the long-run benefits to participants. It is certainly not inconceivable that the programs which are among the least cost-effective from the taxpayers’ point of view, are also those which generate the greatest long-run employment and earnings gains for participants.

APPENDIX Data Used in Deriving Cost Estimates

Variable Definitions

L , = 18% total employment 1978, the percentage of full-time, full-year workers whose wage falls at or below the minimum wage

L2 = 82% total employment 1978 W = mean income for those working full-time, full-year 1978

W, = mean income for those working full-time, full-year at 1978 mini-

W, = mean income (weighted average) of those whose wage is above

L = Total employment 1978

mum wage

minimum [derived by: (LIWl + L , X ) / L = W, solve for X = W,]

for public sector: State and local expenditures in GNP for 1978 B = for private sector: GNP - Government expenditures (1978)

S = (25% minimum wage) X (2,000 manhourdyear) tI. = (W)(L) /B

tl,, = (W,)(L,)/B


TABLE A-1 Values for the Variables used in the Cost Estimates

Variable Private Sector Public Sector

81,650,000 14,779,000 67,326,000 $7.48/hour $2.65/hour $8.54/hour

$1,692 billion $1,320 -1 ,722 .046

-

12,723,000 2,208,000 10,060,oO0 $7.48/hour $2.65/hour $8.54/hour $10 billion $283 billion $1,320 -1 .673 .041

Data Sources

(1) L - Source: Statistical Abstract of the United States: 1980 (1Olst Edition), Washington, D.C., 1980

(2) L , - The 18% figure was derived from the U.S. Census Current Popu- lation Reports showing that for 1976,1977, and 1978 roughly 18% of full-time, full-year workers show mean earnings that put their average hourly earnings at or below the minimum wage.

Sources:

U.S. Bureau of the Census, Current Population Reports, Series P-60, No. 123, “Money Income of Families and Persons in the United States: 1978,” Government Printing Office, Washington, D.C., 1980, Table 62.



(3) W - Source: U.S. Bureau of the Census, Current Population Reports, Series P-60, No. 123, “Money Income of Families and Persons United States: 1978,” Government Printing Office, Washington, D.C., 1980, Table 62.

(4) W, - derived from minimum wage

ECONOMIC INQUIRY 690

(5) B

Source: Statistical Abstract of the United States: 1980, (1Olst Edition), Washington, D.C., 1980.

Source: Statistical Abstract of the United States: 1980, (10lst Edition), Washington, D.C., 1980-

REFERENCES

Ashenfelter, 0. C., “Demand and Supply Functions for State and Local Government Employ- ment: The Effect of Federal Grants on Nonfederal Government Wages and Employment,” in Essays in Labor Market Analysis, eds., 0. Ashenfelter and W. Oates, Halsted Press, New York, 1978,l-16.

Ashenfelter, 0. C., and Ehrenberg, R. G., “The Demand for Labor in the Public Sector,” in Lobor in the Public and Nonprofit Sector, ed., D. Hamermesh, Princeton University Press, Princeton, 1975.55-78.

Bassi, L. and Fechter, A., The Implications for Fiscal Substitution and Occupational Disphce- ment Under an Expanded CETA Title VI, Government Printing Office, Washington, 1979.

Bishop, J. and MacDonald, M., “The Impact of Wage Subsidies on Employment in State and Local Governments,” University of Wisconsin, (mimeo), 1977.

Clark, K. B. and Freeman, R. B., “How Elastic Is the Demand for Labor?,” Review of Eco- nomics and Statistics, November 1980,52,509-520.

Cook, R. F., “Public Service Employment in 1980”. Woodrow Wilson School, Princeton Uni- versity, (mimeo), 1980.

Ehrenberg, R. G., “The Demand for State and Local Government Employees,” American Eco- nomic Review, June 1973,63,386-379.

Gramlich, E. M., “State and Local Budgets the Day After it Rained: Why is the Surplus So High?”, Brookings Papers on Economic Activity, No. 1,191-224.

Hamermesh, D. S., “Econometric Studies of Labor Demand and Their Application to Policy Analysis,” Journal of Human Resources, Fall 1976,11,507-525.

Hamermesh, D. S. and Grant, J. “Econometric Studies of Labor-Labor Substitution and Their Policy Implications,” Journal of Human Resources, Fall 1979,14,518-541.

Johnson, G. E., “The Theory of Labour Market Intervention,” in Jobs for Disadvantaged Workers: The Economics and Design of Target Employment Subsidies, eds. R. Haveman and J. Palmer, Washington, D.C., 1982,57-91.

Johnson, G. E. and Tomola, J. D., “The Fiscal Substitution Effect of Alternative Approaches to Public Service Employment Policy,” Journal of Human Resources, Winter 1977,12,3-28.

Nathan, R. P., Monitoring the Public Service Employment Program: The Second Round, a report to the National Commission for Employment Policy, Washington, D.C., 1979.

Documents

EVALUATING ALTERNATIVE JOB CREATION STRATEGIES