It may sound like a truism to say that work should pay. But does it pay as much as it could, particularly for people on very low incomes? This is precisely what governments have been asking as they bid to get people off benefits and into employment.
And how can governments influence pay to make it more attractive? As it happens, they can do quite a lot, particularly where low-skilled labour is concerned.
There are two broad approaches, the choice of which largely depends on a country’s situation. On the one hand are countries with relatively high minimum wages like France or the Netherlands, where public effort focuses on alleviating social security charges on employers and making labour less costly to hire, while preserving social protection. On the other hand are countries with lower minimum wages and low charges on employers, like Britain and the US, where the policy focus has been on boosting individual disposable incomes via tax credits, rebates and so on.
The problems seem straightforward. For a start, the market wage available to the low-skilled is sometimes too low, compared with welfare benefits, to encourage labour supply. Indeed, some poorer households often move between work and welfare without ever escaping from poverty. Governments can try to make work pay by modifying taxes, minimum wages and other employment-conditional benefits. And if they want to improve out-of-work benefits, in-work benefits may have to be improved even more. Hiring has to be affordable for employers, of course, since if non-wage labour costs, like social contributions, rise, so the demand for low-skilled workers becomes squeezed. This balance also affects discussions about the minimum wage and how to strike a balance between decent pay and affordable costs.
Which of the two main approaches is more effective? That depends. For a start, each approach has to be judged against its particular context, and likewise, it is not certain that, say, the British approach would work as well in Germany, or vice versa.
That said, cost is obviously a good place to start to look when judging performance. At first sight, it looks as if the employment-conditional system is pricier. The British programme for instance costs about 1% of GDP, and though it produced 100,000 extra jobs, the French employer-oriented programme is estimated to have cost half that amount for about the same yield (or more) in employment. In fairness, the British system is part of a much broader approach to redistribution through targeting benefits to low and middle income families, so it cannot be judged simply on the number of new jobs it appears to create. A closer look at policy performance is needed to see where the different approaches deliver and where they fall down.
Take employment-conditional benefits first. These have been around for quite a while, since the 1970s in the US and the UK, which used them mainly to redistribute income rather than boost employment per se. However, if they are not closely targeted, their effects on employment appear limited, at least in relation to what may be a prohibitive cost for every job created.
Employment-conditional benefits are generally directed at families with low incomes, particularly those with children. The amounts paid can be quite high and are not time-limited. The UK system provides employment-conditional benefits for jobs paying up to £58,000 sterling (about US$90,000). The credit applies to salaries as high as this because it is part of a general system of boosting incomes of families with children, not just employment. Recipients have to work a minimum number of hours to qualify.
Tax credits appear to be effective in encouraging lone-parent families and households where no-one works to go to work. This is no bad thing, since lone parents are among the groups with the highest level of joblessness in many OECD countries. In the UK, for instance, there is a very clear “spike” in the hours worked by single mothers in particular, as they reach the number of hours required (24 hours per week) to become eligible for the tax credit.
However, one drawback is that low hours limit their career prospects compared with full-time employment. Moreover, both the US Earned Income Tax Credit and the UK’s Working Family Tax Credit are reported to have actually lowered the employment rate of married women with working spouses. Why? Because benefits are income-tested, they raise marginal tax rates on families above a modest income level. The effect is concentrated on second earners, who can face these high marginal tax rates as soon as they enter the workforce, increasing the incentive to have just one bread winner and less gross earnings so as not to lose the credit.
It seems that employment-conditional benefits work best when they are restricted to bringing in individuals who have little incentive to work otherwise, which is how they are used in France and the Netherlands, where employment rather than redistribution is the aim, where people leaving welfare are targeted and where time limitations on claims may also apply.
For improving pay more broadly, these countries have preferred cuts in employer charges, not least because in these countries such costs are relatively high. The main beneficiaries tend to be very low-skilled workers. However, the approach has drawbacks. For instance, reductions in employer charges tend to apply not just to new recruits, but to longstanding members of the workforce as well. This clearly deprives public budgets of legitimate funding from these employees. Moreover, as the payroll tax reductions come from hiring low-skilled workers, employers may be tempted to forego taking on more skilled recruits, as well as resisting wage increases at the lower end. They may also decide to hire more part-time workers.
Still, the wage-cost subsidy approach appears to produce jobs. In France, policies to cut charges introduced in 1993 created at least 100,000 jobs – some calculate as many as 400,000 – for a total annual cost of 0.5% of GDP. But evaluations of a Dutch system that was expected to produce similar results showed mixed effects on employment, though the low level of the subsidy may have been to blame, and it has since been tripled.
So, while it seems that reducing employers’ social security contributions can boost employment for the low paid, the approach seems to cover too many workers and sometimes the subsidy goes to employers that do not need it.
One way around these problems is to introduce tighter targeting, including actual wage subsidies. Though they carry running costs, such subsidies are a sensible approach and are widely used as they can help particular groups like the long-term unemployed or older workers. The take-up rate of targeted schemes is poor in some cases, and can stigmatise particular target groups, compromising their career chances. Also, their temporary nature can increase labour turnover if employers fill the same post using the subsidy. This can be overcome though, by, for instance, stopping benefit to employers that take advantage, or including training requirements that may bind the employee more closely to the firm.
In short, the jury is still out on how best to make work really pay, the choice of strategy being a matter of context and judgement. Two lessons seem clear from all approaches. First, that some form of minimum wage is a key part of the “making-work-pay” toolbox. But it is a tricky element, since although a floor for wages can help reduce poverty and inequality, if set too high it can raise wages for the very unskilled to untenable levels, and so keep them in unemployment. On the other hand, lowering minimum wages may make staying out of work seem more attractive to many. Again, the way forward may be to cut employers’ non-wage labour costs at or around the minimum wage level, so that take-home pay is maximised at no expense to the firm.
The second lesson is that striking the right work/life balance is a vital part of the task, particularly when it comes to disadvantaged groups. Take female workers. Those countries with the highest overall labour market participation rates are those where women’s participation is also high. Of course not all women want to go out to work. Yet, policies which help to reconcile work and family life may be needed in the case of mothers with young children who want to work – as Nordic countries have long demonstrated. Childcare support is one such lure.
This type of thinking applies to almost any disadvantaged or minority group, whether sick, old or ethnic, and taking account of all these demands is important in building a complete package to make work pay.
OECD (2003), Employment Outlook, Paris
©OECD Observer No 239, September 2003