Wage subsidies are a well-meant but ineffective tool for reducing unemployment

In President Mbeki’s recent state of the nation address he alluded to the idea that South Africa would be introducing some form of social security. The President said that part of this ‘new’ social security system would consist of a wage subsidy aimed at low-income employees and “possibly directed at first time entrants into the job market, especially young people”. But how exactly would the subsidy operate and would it have the desired effect of reducing youth unemployment?

If adopted the subsidy would either be aimed at stimulating demand for labour through the use of some form of tax credit offered to employers or focussed on the supply side of the market, through some form of tax rebate offered to employees. A combination of the two would presumably consist of a tax credit for the employer that is passed straight on to the employee in the form of a tax-free wage subsidy.

In essence, SA’s progressive tax system, already exempts low-income employees from paying tax. An exemption for low-income earners is beneficial for both compassionate and practical reasons. Indeed, there is no merit whatsoever in taxing the poor. The compassionate reasons are obvious while the practical reason is that below a certain level of income the costs of collecting taxes from the poor will exceed the amount collected. Furthermore, given the large body of unemployed and particularly discouraged work seekers in SA the unemployment problem clearly does not stem from the supply side of the labour market.

On the opposite side of the wage subsidy coin is a policy aimed at stimulating demand for labour. Demand for labour could possibly be stimulated by offering an incentive to employers presumably through the use of some form of tax deduction. But it is highly unlikely that potential employers will be willing to go through the additional red tape that is likely to arise from the proposed wage subsidy to employ a very narrow group of individuals.

Unemployment has been a regular fixture in the South African economy since at least the mid-1970’s. According to the latest labour force survey approximately 4.2 million potential workers are unemployed in SA, which equates to an official unemployment rate of approximately 26%. If we include discouraged work seekers, those that have given up searching for work because they believe that there is simply no work available, the number of unemployed jumps to 7.9 million, representing an expanded unemployment rate of approximately 39%. However, if we focus exclusively on the 15-24 age group according to the strict definition of unemployment, we observe that approximately 50% of the youth are unemployed. Clearly something has to be done for the vast body of individuals, mainly young people, who are currently unemployed.

Recognising the severity of the problem the Parliamentary Portfolio Committee on labour called for submissions on youth unemployment in March last year. From certain quarters within the ANC came the call to relax the labour laws applicable to young and low skilled labour market participants. Indeed, the World Bank has also called for relaxations on SA’s labour laws. Despite the South African governments’ best intentions in wanting to protect workers, an unintended consequence of the present labour laws is that they effectively prevent the unemployed from gaining employment.

The sayings, ‘if you can’t fire you don’t hire’ and ‘you can’t hire those who don’t earn their keep’ may be unpalatable to politicians but they are harsh realities of employing responsibly. If government reduced the bureaucratic red tape and relaxed the statutory requirements that prevent people from getting jobs in the formal sector it would not be necessary for so many people to turn to the informal sector for employment.

The ANC suggestion to allow labour market forces to function unhindered for young people at the low end of the market would benefit large numbers of jobless people if implemented. Young people would not have such a desperate struggle to get onto the first rung of the employment ladder. Not unexpectedly, the already employed argue that any weakening of job-security legislation and erosion of minimum wages will lead to increased poverty but studies have shown that a significant driver of poverty is unemployment.

An alternative that will not disturb the job security of the employed yet give the unemployed the opportunity to find jobs is to give anyone who has been unemployed for more than six months a two-year exemption from the labour laws and allow the exempted person to make any written arrangement with an employer he or she wishes. The proposal will not solve the unemployment problem overnight but it will give hope and provide job opportunities to the currently hopeless.

Author: Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article/ 20 February 2007