Another Myth about the Youth Wage Subsidy | by Christopher Malikane

by Jul 9, 2012All Articles

another-myth-about-the-youth-wage-subsidyThe National Treasury, informed by its discussion document, “Confronting Youth Unemployment—policy options for South Africa” published in February 2011, has set aside R5 billion to finance the youth wage subsidy.  This subsidy aims to close an alleged gap that exists between the real wages of young people and their productivity.  In the Sunday Independent (17 June 2012), I have shown that actually, young people in South Africa are on average nominally paid R1 053 less than their productivity on a monthly basis, and in real terms this amounts to R726.  The National Treasury (and the DA) further argues that international evidence supports their proposed youth wage subsidy.
SAPA (12/06/12) quotes Ms Lindiwe Mazibuko of the DA as having said “Cosatu spreads lies over youth wage subsidy”.  Ms Mazibuko is further quoted as having said: “Plenty of research has been commissioned to test the validity of the youth wage subsidy all over the world…It shows that young people will get absorbed in the workplace. There is no substitution and no exploitation.”  She is also reported to have referred to Singapore and the UK as examples where the youth wage subsidy has been successful.  Even the IFP is reported to have nailed its mast in support of the subsidy. Indeed the Treasury document dedicates quite some time to demonstrate that the youth wage subsidy works internationally.
In this brief note I address this so-called international evidence by drawing from a detailed draft Cosatu response to the Treasury document. I leave the question of substitution for later interrogation.  I hereby show that the National Treasury document deliberately exaggerates what international literature says about youth wage subsidies, in favour of its proposal. This unwarranted and exaggerated presentation of international literature leads to a distorted view of what is going on internationally.  In order to demonstrate these distortions I will refer to the same papers that National Treasury uses and show that these papers lean more towards a Cosatu position than the Treasury’s (and the Democratic Alliance’s) position.  The Treasury document refers to thirteen countries. The DA has now added Singapore on the list. We searched the DA website and could not find the literature upon which the DA bases its claims about Singapore. Due to space limitations, I will deal with the UK, US, Germany, Turkey, Colombia and Argentina.  Evidence for the rest of the countries is broadly similar to what I report here.
In relation to the US, the Treasury document relies on a paper by Katz (1996).  In that paper Katz concludes that the US employment subsidy “has no impact on the earnings or employment prospects of out-of-school disadvantaged youth…like other non-intensive strategies that have been evaluated, it does not appear very effective for out-of-school youth from poor families”. These observations clearly do not support the National Treasury and the DA. Even though the youth wage subsidies in the US may have had “modestly positive employment results” as Katz also reports, such results have been statistically insignificant and they have been ineffective for out-of-school youth, who are more than 95% of the South African unemployed youth.
In the case of the UK, the paper by van Reenen (2003) shows that the “New Deal” for young people consists of a range of options for young people to pursue their development.  The youth wage subsidy option is therefore one among a number of options and it is the least preferred by young people because of its potential career-limiting effect.  Its impact on employment is also contaminated by the effects of other interventions, such as job-search assistance to young people. The UK Department of Business, Innovation and Skills is opposed to youth wage subsidies.  In 2009 it submitted: “Our conclusion is that this is not a feasible, cost effective or sustainable option for us. We also know, based on our experiences of the 1970s, that these schemes can create distortions and prevent companies taking necessary action to restructure or retrain to ensure their survival and success in the future, leading to failure and redundancies when the subsidy is removed”.  Therefore the UK government also does not support the National Treasury and the DA position. Further evidence also reveals that young people in the UK, and in fact everywhere, prefer an option of raising their education attainment than be thrust into the labour market without skills and basic cognitive abilities.
In relation to Germany, the hiring subsidies to which the Treasury document refers are targeted at workers aged 50 and above.  Just how these can be thought to provide evidence that the youth wage subsidy works remains a mystery. The paper by Jaenichen and Stephan (2007) states: “Our results show that wage subsidies may increase the employment prospects of supported workers to a considerable amount”, that is, the supported grand-dads and grand-moms. These authors then note that “a comparison between groups of unemployed persons taking subsidised employment with matched control groups of individuals moving directly into unsubsidised employment indicates that differences in the employment prospects are rather small after three years”. The supposed claim of a huge impact of the subsidy is therefore not supported. Other literature, such as Schünemann and others (2007) find that for Germany, “the results suggest no significant effect of the subsidy on exit rates out of unemployment or employment stability. Employment rates up to three years after eligibility show no significant improvement”. So, the German experience does not support the National Treasury and the DA.
In Turkey the paper by Betcherman and Daysal (2009) shows that the subsidies were not for young people.  Nevertheless it reports: “The evidence suggests that the dominant effect of subsidies was to increase social security registration of firms and workers rather than boosting total employment and economic activity…the gains in employment and number of firms correspond to a surge in formalisation, rather than to real gains in economic activity…our results also suggest that implementing the subsidies can be a costly way to increase employment…the government ended up paying for nearly the full cost of employment created”. This clearly does not support the use of subsidies for job-creation. The Treasury document smoothes over this damning evidence by saying that “formalisation as a result of the subsidy would be a positive effect and consistent with government’s aims to increase formalisation in the economy”.  But why do we need to have a youth wage subsidy to formalise business enterprise? Is the youth subsidy not meant to increase the employment prospects of young people, rather than formalising enterprises?
In Colombia the Treasury relies on a paper by the Ministry of Social Protection (2004). We could not find this paper.  But the paper by Attanasio and others (2009) analyses Colombia’s vocational training programme called the “Youth in Action”.  The authors find that: “Training offers increase the probability of having a formal sector job by 0.053. The results also show that the offer of training increases the probability of having a written contract by 0.066”.  In other words, those who are not part of the program have a 6.6 percent less chance of getting written employment contract.  This is a very small improvement, especially because the “Youth in Action” program “consisted of 3 months of classroom training and 3 months of on-the-job training” in a whole range of skills that South African unemployed youth can only dream about.  The Colombian program is vastly different from the “cold turkey” approach of National Treasury’s and the Democratic Alliance’s youth wage subsidy, but still yielded very modest results. There seems to be evidence of destructive churning in the Colombian program, where employers fire young people repeatedly, i.e. people change more frequently and there is little job-retention once the subsidy is removed.
In relation to Argentina, the paper by Galasso, Ravallion and Salvia (2001) concludes that “the impact of the voucher [or subsidy] was clearly not through access to the wage subsidy by firms…The voucher may well have encouraged workers to make more effort to find work. By this interpretation, the voucher had an “empowerment” effect, in making these workers -notably young and female workers – more confident in approaching employers…clearly, [the subsidy] did not succeed in achieving a major transition to private sector jobs amongst workfare recipients in the study area”. But the Treasury document presents an unjustifiably, extremely, overly optimistic picture about the youth wage subsidy in two towns of Argentina.  It must be noted that in Argentina, because employers had to register workers to claim the subsidy and at the same time were reluctant to formalise their businesses, they did not hire subsidised workers.  The contrasting evidence between Argentina and Turkey shows that there is not even conclusive evidence that employment subsidies increase formalisation of business enterprises.
Reference that international evidence supports the youth wage subsidy is one of the biggest myths propagated by subsidy pushers. The international literature upon which the National Treasury and the DA rely to support their position on the youth wage subsidy tends to point in the opposite direction.  Either the National Treasury authors have not fully understood the papers they were using, or they were deliberately selective in their reading of the literature.  As for the DA, it is most probably the case that they simply relied on the “goodness” of Treasury researchers to base a national political campaign without checking the evidence.  We should perhaps forgive the old man Chief Buthelezi, who just wants anything that promises jobs even if there is no evidence that it does so.
Whilst Ms Mazibuko confidently points us to international evidence, which is full of statistics, she states, in her 2012 June 16 message to South African youth: “This is not the time for cold statistics, it is a time for empathy and understanding”. As soon as she says this, she jumps straight into “cold statistics”: “Half of all South Africans below the age of 25 are unemployed. That means that one in two young people you pass in the street, see at church or the mosque, travel with in a taxi, or sit next to at the clinic, does not have a job”.  This, however, does not paint anything. She must read the Socio-Economic Report presented at the 5th Central Committee of Cosatu in 2011 and the facts contained in the Growth Path towards Full Employment document of Cosatu, to get a vivid picture of what she attempts to say. Once a person rejects statistics only to use them when they please, the room for scientific engagement narrows significantly and scope for myths rises dramatically
Christopher Malikane is an Associate Professor of Economics at Wits University and a Policy Advisor to COSATU
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