Active labour market policies do not increase wage pressure

It has long been considered that the extensive active labour market policies (involving subsidised employment and training schemes) implemented in Sweden during the recession of the 1990s placed upward pressure on wages. However, a study conducted by two researchers at the Office of Labour Market Policy Evaluation (IFAU), issued in November 2000, finds that this was not the case.

Extensive labour market programmes, offering subsidised employment and training to unemployed people, do not significantly contribute to increasing pressure on wages. This is the main finding of a paper published in November 2000 by two economic researchers at the governmental Office of Labour Market Policy Evaluation (Institutet för arbetsmarknadspolitisk utvärdering, IFAU), Anders Forslund and Ann-Sofie Kolm ("Active labour market policies and real-wage determination - Swedish evidence", Working Paper 2000:7, IFAU). The aim was to investigate whether the extremely poor conditions in the Swedish labour market throughout much of the 1990s, and the very high incidence of labour market programmes, had brought about a change in previously observed patterns. A number of earlier studies on the same problem have concluded that the effect of extensive labour market programmes is indeed significant, in that they push wage pressure upwards in the Swedish economy.

Active labour market policies and wages

Sweden has a long tradition of active labour market policies. During the recession of the 1990s, the volume of such programmes reached an unforeseen level, encompassing almost 5% of the labour force in 1994. The researchers state that the use of active labour market programmes rather than "passive" income support to unemployed workers can be justified on several grounds, for example:

  • if active policies improve the matching between vacancies and unemployed workers, they may result in higher employment and lower unemployment;
  • if active policies involve skill formation among unemployed people, they may improve employment prospects among the unemployed;
  • if the programmes improve the position of "outsiders" in the labour market, they may reduce wage pressure; and
  • to the extent that they stop the "depreciation of human capital" among the unemployed, active policies may keep labour force participation up.

In all these respects, successful active labour market policies provide a better alternative than income support for the unemployed workers.

Achieving these effects may, however, be quite expensive. Programmes in the form of subsidised employment may cause direct "crowding out" of normal employment. Furthermore, to the extent that labour market programmes provide a better alternative than income support for the unemployed this may cause unions to push for higher wages, since "the punishment for higher wage demands become less severe if union members are better off than they would have been as unemployed workers". The net effect of labour market programmes on wage pressure will, however, in general be ambiguous, the researchers state, as they result in influences working both to lower and to raise wage pressure.

The new research

Although a fairly large number of earlier studies have examined this issue, the researchers state that there were at least three reasons to undertake yet another study:

  1. most studies use data predominantly from the decades before the 1990s, when both unemployment rates and labour market programme participation were much lower than they have been since;
  2. not only the volume but also the composition of the programmes changed in the 1990s; and
  3. there have been some recent developments in time-series research methods, primarily related to the analysis of "non-stationary time series". A careful application of these methods may provide new insights and enable the robustness of the results to be checked with respect to different "empirical modelling strategies".

The researchers thus used a new and more complex research methodology than most previous studies of Swedish wage-setting.

The main finding of the research, contrary to most previous studies, is that extensive labour market programmes seem not to contribute to increased wage pressure. This may reflect the fact that Swedish labour market mechanisms changed in the face of the recession or that the different mix of measures used during the 1990s made a difference.

Why the new findings?

To explain why their findings differ from those of early studies, the researchers (after extensive examination of other possibilities) point especially to two possible explanations - the use of different models and of different data. They conclude that the "prime suspect" for the difference in results is data revisions.

Specifically there are two main novelties in the data set relating to wages used in the study. First, the researchers have computed a completely new income-tax rate series. Second, all the data that derive from National Account Statistics have undergone several revisions since the late 1980s, some of which have resulted in substantially revised series for a number of variables, especially in the 1980s. Apparently, these changes have had a major impact on estimates of "aggregate wage equations".

Commentary

The IFAU researchers seem to have turned upside down an established "truth" - that extensive labour market programmes increase wage pressure. The researchers now claim an opposite "truth" - that large-scale active labour market programmes do not influence wage pressure. The main reason for these different findings derives from the use of revised data. While one has to be careful not to rely on the results of a single study and draw the wrong conclusions, the study is valuable in that it suggests that, in a possible future situation of high unemployment, the government should perhaps not be afraid of pursuing an active labour market policy. (Annika Berg, Arbetslivsinstitutet)

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