What we’re reading about labor costs, employment incentives and the broader jobs agenda

Labor costs can be a key determinant of job creation. In developing economies where informal employment remains common, it has also been argued that labor costs can contribute to informality by making employment “off the books” more attractive to employers in relative terms, especially in contexts where labor productivity is low.

When high labor costs are identified as a binding constraint to job creation and formality, a natural policy response is to reduce the costs of labor for firms through the provision of job creation incentives. Such measures have been implemented to cope with a transitory negative shock hitting the economy, such as during the COVID-19 pandemic and other economic downturns. These have also been used to address structural employment issues and promote job creation for specific vulnerable groups or in specific regions within a country where employment and economic activity are lagging.

Several approaches are being followed by policy makers to lower the costs of labor. The two main policies that have rigorously been studied, albeit mostly in high-income settings, are payroll tax cuts and private employment subsidies. These measures can be applied to all types of establishments and workers, or be targeted to specific sub-groups, including low-wage, youth, long-term unemployed, women, or disabled workers.

In this reading list, we feature a recent publication “The Effects of Subsidizing Social Security Contributions: Job Creation or Informality Reduction,” which focuses on the case of the Republic of Türkiye. Subsidizing social security contributions can have positive and sizeable effects on formal employment in small firms. According to the publication, these positive effects are mostly driven by the conversion of informal employment into formal employment, rather than new job creation.

We also feature publications that contribute to the growing literature on labor costs and employment. Finally, we present a selection of articles that discuss the broader jobs agenda, as well as COVID-19 related articles.

Essential readings: Labor costs and employment incentives 

• This paper shows that social security contribution subsidies have positive and sizeable effects on formal employment in small firms, in the context of a developing economy where informality is common (Türkiye). (Aşık et al., World Bank, January 2022)
• Payroll tax cuts could be a way to stimulate firm activity during downturns and could even be more effective than VAT rate cuts. (Benzarti & Harju, Journal of Public Economics, August 2021)
• This paper highlights key patterns pertaining to the effectiveness of interventions to reduce informality in low- and middle-income countries. (Jessen & Kluve, World Development, February 2021)
• A Finnish payroll tax subsidy scheme—which was targeted at employers of older, full-time, low-wage workers—had no effect on the employment rate or wages of the eligible groups but increased their working hours. (Huttunen et al., Journal of Public Economics, January 2013)
• In settings with some degrees of wage rigidity, location-based payroll tax incentives can be beneficial in stimulating local employment. (Ku et al., Journal of Public Economics, November 2020)
• The extra job experience gained as a result of the wage subsidy does not provide a stepping-stone to new jobs for these recent graduates, which appears to be due to productivity levels not rising above a binding minimum wage. (Groh et al., The Review of Economics and Statistics, July 2016)
• There is a need for a policy response that includes countercyclical job training programs and private employment subsidies, which are especially effective for the longer-term unemployed in a recessionary climate. (Card et al., Journal of the European Economic Association, June 2018)

Broader jobs agenda

• Violence due to drug trafficking in Mexico has a significant negative impact on the country’s plant output, product scope, employment, and capacity utilization. (Hâle Utar, IZA, March 2022)
• This paper proposes a new mechanism to explain resource misallocation in developing countries and how informality can be reduced. (Roman Zarate, World Bank, March 2022)
• This paper identifies and discusses five main pathways through which temporary migration affects development at origin countries. (Bossavie & Özden, World Bank, April 2022)
• This paper suggests that the structural transformation in Sub-Saharan Africa brought about by road and electricity expansion is primarily a rural phenomenon. (Abbasi et al., World Bank, March 2022)
• This paper shows that higher wage elasticities with respect to density are due to higher marginal costs and agglomeration elasticities of efficiency. (Grover & Maloney, World Bank, March 2022)
• The rise of employment in mega firms is concentrated in the 30 industries that dominate rising earnings inequality. Among these industries, earnings differentials for the mega firms relative to small firms decline in the low-paying industries but increase in the high-paying industries. (Haltiwanger et al., National Bureau of Economic Research, April 2022)

COVID-19-related articles

• Globally, female-led firms were, on average, 4 percentage points more likely to close their business and experienced larger revenue declines than male-led firms during the COVID-19 pandemic in 2020. (Goldstein et al., World Bank, April 2022)
• The COVID-19 pandemic induced a labor market mismatch that rose sharply at the onset of the pandemic but returned to previous levels within a few quarters. (Pizzinelli & Shibata, IMF, January 2022)
• Job retention schemes have played an essential role in mitigating the pandemic’s impact on labor markets and have facilitated the restart of European economies after the initial lockdowns. (Ando et al., IMF, March 2022)
• Using annual firm financial data and high-frequency data related to COVID-19 pandemic production shocks, the paper offers a new dataset and methodology that can be used to track firm-level activities more consistently, especially in places where information on such activities does not exist or is not systematically reported. (Bilicka & Seidel, April 2022)

This blog is based on the April 2022 edition of the Knowledge4Jobs newsletter, curated by the World Bank’s Jobs Group and Labor and Skills Global Solutions Group. Click here to sign up for the Knowledge4Jobs newsletter