In recent years, policy-makers have come to recognize the potential importance of subsidizing jobs for currently unemployed people. But despite the growing interest in the design of such policies, there has been little dynamic analysis of the optimal policies and their employment effects. In Discussion Paper No. 1367, Michael Orszag and Research Fellow Dennis Snower analyse the short- and long-term effects of vouchers on unemployment, identify the major channels whereby this policy works, examine the main obstacles inhibiting the effectiveness of the policy, and investigate the role of the government budget constraint on policy formation.

Their analysis concentrates on six major determinants of optimal employment vouchers: (i) dead weight – vouchers given to people who would have found a job anyway; (ii) hiring responsiveness – the effect of vouchers on the hiring rate; (iii) autonomous job loss – the flow from employment into unemployment in the absence of vouchers; (iv) displacement – the effect of the vouchers on the flow from employment into unemployment; (v) unemployment benefits; and (vi) the budgetary allocation for policy – the government budget deficit or surplus that is to be generated through the policy. They show how the government budget constraint makes the optimal employment vouchers depend positively on the existing unemployment benefits and how this relation is conditioned by the problems of deadweight and displacement. The analysis relates the optimal employment policies to the economy’s underlying hiring and firing activities and it specifies the conditions under which these policies can be self-financing.