Download An Economic Evaluation of the Jobs Credit Scheme

AN ECONOMIC EVALUATION OF THE JOBS CREDIT SCHEME
Tan Boon Seng
Assistant Professor
The Hong Kong Polytechnic University
Department of Management and Marketing
Hung Hom, Kowloon, Hong Kong
Telephone: 852-27664057; Fax: 852-27650611
Email: [email protected]
Abstract
We estimated the effect of the Jobs Credit Scheme (JCS) in saving local worker’s job
from retrenchment using a standard one-period production model of output
maximization under a labor budget constrain. The JCS was effectively a wage subsidy.
We assumed the isoquant was determined by a Cobb Douglas production function
using estimated capital cost share from the literature. We evaluated the extent of job
loss under four scenarios of economic contractions in 2009: optimistic (-2%),
expected (-5%), pessimistic (-10%) and catastrophic (-20%). We found that the JCS
would effectively become a fast acting corporate tax cut favoring labor intensive firms
because most of the benefit accrued to the firm. The JCS had a substitution effect that
could save 5% to 66% of the local worker from job loss that would occur without it,
but was less effective in more serious economic contractions. Our model’s prediction
of job loss was bias upwards because of rehiring cost in the more realistic multiperiod models, and that firm could use other temporary measures to reduce wage costs.
Keywords: Wage Subsidy (H25), Cob Douglas Production Function (D24),
Substitution Effect (D21)
1. Introduction
The Jobs Credit Scheme (JCS) is a one-year program, announced during the
Singapore Budget 2009, to encourage employers to retain local workers. The $4.5
billion program is part of a $20.5 billion stimulus package, the “Resilience Package”,
that include fiscal spending for tax reduction, stimulating bank lending, building
infrastructure and expanding the civil service. (All currency in this paper is Singapore
dollar where 1US$ = S$1.52 approximately in 2008). The package, which costs 6% of
Singapore’s GDP, is currently the most aggressive economic stimulus, on a per capita
basis, in the world. The parliamentary debate on the package focuses on the cost
effectiveness of the JCS: Can the JCS save jobs for local workers? What is the
economic cost for providing the benefit?
We examine the economics of the JCS and estimate its effect on the choice of worker
mix. We use a scenario analysis approach because forecast of future demand is
difficult to obtain, but feasible ranges are available. Assuming that decision makers
are rational, and output is determined by a Cobb Douglas production function, we
estimate the number of local jobs that the JCS can save and the deadweight loss for
four scenarios.
In the following sections, we review some background information before proceeding
with the modeling. Then, we describe some relevant features of Singapore’s labor
policy in Section 2, the mechanics of the JCS in Section 3, develop our model in
Section 4, discuss the result and limitation in Sections 5 and 6, and summarize our
findings in Section 7.
2. Some Aspects of Singapore Labor Policy
We focus on two aspects of Singapore’s labor policy to provide a context for the JCS.
First, we outline the salient features of the Central Provident Fund (CPF), which
influence the wage cost of local, but not foreign, workers. Second, we highlight the
classifications of foreign workers in Singapore, and the policy regulating the
employment of these classes of foreign workers. This information provides the
context of the employment of foreign workers in Singapore. A comprehensive review
of other aspects of Singapore labor policy are addressed elsewhere, see for example
Fong and Lim (1982).
2.1 The Central Provident Fund (CPF) Scheme
The CPF scheme is a mandatory, funded social security scheme for local workers, but
foreign workers are excluded. Employers and workers jointly contribute a portion of
the gross wage to individual accounts. The CPF does not involve inter-generation
transfer through tax because it is accumulated individually during one’s working life.
Originally intended as a scheme for funding retirement, the CPF has become the main
source of finance for housing and various other schemes. 1 The administration of
paying Jobs Credit in the JCS is tied to CPF (more in section 3).
If workers receive the same gross wage, CPF payment creates a difference in their net
wages because employers need to contribute a share to the local worker’s CPF.
However, employers are indifferent to hiring a local or a foreign worker for the same
net wage. As of 1 Jan 2009, local workers below age 50 pay 20% of their monthly
wages to CPF, and their employers pay another 14.5%, making a total contribution of
34.5% of gross wage. Contribution rates are lower for workers above age 50, and for
those earning below $1,500 a month. There is no CPF contribution required for the
portion of wage above $4,500. For workers earning between $1,500 and $4,500 a
month, the CPF contribution rates are as follows:
Employee’s Age Employer Employee Total
Below 50
14.5
20.0
34.5
50 to 55
10.5
18.0
28.5
55 to 60
7.5
12.5
20.0
60 to 65
5.0
7.5
12.5
Above 65
5.0
5.0
10.0
Table 1: CPF Contribution Rate as % of Wage by Age
(Note: The retirement age is 62 years old as of 1 Jan 2009)
If an employer offers a local worker below age 50 a gross monthly wage of $2,000,
the net wage is $2,290 including the employer’s CPF contribution, and the local
worker takes home $1,800. The employer is indifferent to offering $2,290 for a
foreign worker before deducting the applicable levy. The take home pay of the foreign
worker is the amount after deducting the foreign worker levy, which ranges from 0 to
$470 a month.
2.2 Foreign Labor Policy
The non-resident population in Singapore, which is those who are not citizens or
permanent residents, was 2.9% in 1970 for a population of 2 million. However,
foreign workers constituted 29% of Singapore's total labor force by 2000, which was
the highest proportion of foreign workers in Asia. The increasing share of the nonresident population was a direct consequence of policy to attract and rely on foreign
manpower, at both the high and low ends, to overcome the limits of local workforce.
The number of higher skilled and better-educated foreigners increased rapidly as a
result of intensive recruitment and liberalized eligibility criteria in the recent decade.
The policy on foreign workers is administered through a system of work permit and
employment pass. The work permit, or R pass, for lower skilled worker is based on
the principle of confining them as a temporary workforce: The R pass is tied to an
employer and not transferable, R pass holders are not eligible for dependent and long
term social visit passes, and hiring R pass holders attracts high levies. High skilled
workers qualify for employment pass known as P, Q and S passes. These employment
passes qualify for dependent pass. P pass qualify for dependent pass and long term
1
The current uses of the CPF also include funding for hospitalization, education, investment and
retirement. However, above 50% of the CPF withdrawal each year is for home financing since 1970.
social visit pass. The types of employment passes and their essential characteristics
are summarized in the following table:
Type Eligibility
P1
Foreigners with basic monthly salary >S$7,000
P2
Foreigners with basic monthly salary from S$3,500 to
S$7,000 with acceptable degrees, professional
qualifications, or specialist skills
Q
Foreigners with basic monthly salary > S$2,500, and
with acceptable degrees, professional qualifications, or
specialist skills
S
Foreigners with basic monthly salary > S$1,800 and
with acceptable diploma
R
Foreigners with basic monthly salary < S$1,800
DP
Yes
Yes
LTSVP
Yes
Yes
Yes
No
Conditional No
No
No
Notes:
1. Dependent Pass (DP) allows the worker’s spouse and children under 21 years
old to stay in Singapore. Long Term Social Visit Pass (LTSVP) allows the
above group, and also includes parents, parents-in-law, step-children and
handicap children.
2. S pass holders may obtain Dependent Passes if the monthly salary > S$2,500
3. R pass holders are subjected to a security bond; a medical examination is
required for approving two-year work permits.
4. S pass holders need to pay a levy of S$50/month. R pass holders pay higher
levies depending on the sector they are employed and skill categorization.
Table 2: Types of Employment Passes and Permits
Quotas are set for lower skilled foreign workers, which include R and S pass holders,
based on industry, but there is no limit on hiring P and Q pass holders. The minimum
proportion of local worker is 12.5% for construction sector, 16.7% for marine sector,
35% for manufacturing sector, and 50% for service sector. The maximum proportion
of S pass holders is limited to 25% for all sectors. Source country restrictions apply
for all industry sectors. For instance, firms in the services sector are allowed to recruit
R pass holders from Malaysia, Hong Kong, Macau, South Korea and Taiwan only.
About 580,000 of the 756,300 foreign workers in 2006 were R pass holders (Yeoh,
2007): About 135,000 in the construction industry, 160,000 in domestic maid services,
and the remaining 285,000 in service, manufacturing, marine and other industries. The
remaining 176,300 foreign workers comprise of about 25,000 S pass holders, 65,000
Q pass holders and 86,300 P pass holders.
3. Mechanism of the JCS
Employers, except local and foreign government organizations, who have made CPF
contributions for their workers, are automatically eligible to receive Jobs Credit. The
Jobs Credit is paid in four installments, and is computed using the employer's CPF
contribution data. For workers on the payroll for the months of January, April, July
and October in 2009, the employer will receive Jobs Credits in March, June,
September and December 2009 respectively. The amount of Jobs Credits is 12% of
the first $2,500 of gross wage for each eligible worker. This means the employer will
receive up to $900 per worker for each installment (12% x $2,500 x 3 months).
Therefore, the Jobs Credits is essentially a wage subsidy of local workers which is
paid to the employer. The subsidy is $300 a month for workers with gross salary
above $2,500, or 12% of the gross wage for workers with less income. The $2,500 cut
off is the median wage for workers in Singapore who pay CPF. There are 1,461,900
CPF members in 2006 (CPF Board, 2007), and the number of workers with gross
monthly wage of less than $2,500 is as follow:
Monthly
Wage ($)
Number
(000)
Up to 200 - 400 - 600 - 800 - 1,000 - 1,500 - 2,000 200
399
599
799
999
1,499
1,999
2,499
21.4
27.4
54.2
79.7
67.2
178.5
192.4
176.9
Table 3: Number of CPF contributor with Monthly Wage below $2,500 in 2007
Using the above data, workers earning below $2,500 a month has an average wage of
$1,357. Since the median wage is $2,500, half of all workers contributing CPF in
2006 earn more than $2,500, and half earn less than that.
4. Model Specification
The model is set up to answer two questions: Can the JCS save jobs for local workers?
What is the cost for providing the benefit? Even when job loss data in 2009 becomes
available in future, it is not possible to tell if the job loss will be worse, or better, if the
JCS is not implemented. We solve this problem by developing a model as follows:
Figure 1: A Model of the Jobs Credit Scheme
Consider the economy as one big firm. The y-axis represents the number of foreign
workers (Lf) in the economy, the x-axis the number of local workers (Ls) in the
economy, the curve is an isoquant which represents the bundles of possible labor
inputs to produce a fixed level of output using a fixed level of capital. There are many
other isoquants in the diagram which are not drawn. Higher isoquants, which are
located on the north-east, have higher outputs. The average monthly wages for a
foreign worker and a local worker are wf and ws respectively. The labor cost, which
constrains the economy from choosing the highest isoquant possible, is wfLf + wsLs.
The labor cost before introducing the JCS is represented by the line AB, which is an
isocost line. The economy chooses the optimal mix of labor represented by the bundle
X on the isoquant: This is the most north-east isoquant constrains by the isocost line
AB. Therefore, X lies on the tangent of AB and the isoquant. The JCS changes the
relative price of hiring foreign and local workers, shifting the isocost line to AC. If the
economy expands, the new bundle will lie on the tangent of AC and a higher isoquant.
If the economy stays the same size, a rational firm maximizing its profit will choose
the bundle Y, which has more local and less foreign workers. If the economy contracts,
the optimal labor combination will be south west of Y. Depending on the degree of
contraction, the number of local workers in employment can be less than at X. The
number of local job saved is calculated from the difference between the numbers of
local workers in employment with and without the JCS. The difference will always be
positive because of the flatter isocost after the price change due to the JCS.
The model can be applied to the industry sector level, or the firm level, using suitable
data. At the firm level, an expansion of the isoquant is possible for some firms even in
a recession. We confine ourselves to the economy level in this paper. Quantitative
result can only obtained for a known production function. Therefore, we assume the
output of the economy is given by the Cobb Douglas production function
Y = AK γ Lαf Lβs
Y is the output (GDP), A is the total factor productivity (TFP), K is the level of capital
stock, and α,β,γ are parameters of the production function. We can obtain the
marginal products of labor, for the foreign and local workers, by partial differentiating
the production function. From standard production theory, the marginal product of
labor is the net wage for a profit maximizing firm. Therefore,
wf =
∂Y
∂L f
= AK γ αLαf −1 Lβs , ws =
∂Y
∂Ls
= AK γ Lαf βLβs −1 and wf/ws = αLs/βLf
Let the parameters in 2008 be denoted with subscript 0, and that of 2009 with
subscript 1. For example, Y0 and Y1 are the GDP for 2008 (actual) and 2009
(forecasted) respectively. Taking the difference between the logarithms of the Cobb
Douglas production function for these years, we can say that:
ln(Y1/Y0)= ln(A1/A0)+ γln(K1/K0)+ αln(Ls1/Ls0)+ βln(Lf1/Lf0), hence
αln(Ls1)+ βln(Lf1)= ln(Y1/Y0) - ln(A1/A0)- γln(K1/K0)+ αln(Ls0)+ βln(Lf0)……(1)
In the current period, a firm is indifferent to paying the same net wage to local or
foreign workers. Therefore wf0/ws0 =1, and hence αLs0 = βLf0. If the JCS is not
introduced in 2008, in the next period αLs1 = βLf1. Let us denote the variables after
introducing the JCS with an asterisk (*) superscript. With the JCS, the wage ratio
changes to a new value θ, where wf1*/ws1* =θ >1, and αLs1* = βθLf1*. Substituting this
result into equation (1) to eliminate Lf1*, since we are interested in the effect on local
workforce, we obtain after some algebraic manipulation:
(α+β)ln(Ls1∗) = ln(Y1/Y0) -ln(A1/A0) -γln(K1/K0) +αln(Ls0)+βln(Lf0)–αln(α/θβ) ......(2)
We obtain the case without JCS by letting θ =1:
(α+β)ln(Ls1) = ln(Y1/Y0) - ln(A1/A0)- γln(K1/K0)+ +αln(Ls0)+βln(Lf0)- αln(α/β) ......(3)
Simplifying (2) and (3), we obtain ln(Ls1∗/Ls1) = (α/(α+β)).ln(θ) ......(4)
Equation (4) shows that the incremental percentage of jobs saved by the JCS is
independent of the contraction of the economy, but is dependent on the production
function parameters and the change in the wage rate. To obtain the number of jobs
saved by the JCS requires estimating Ls1 in equation (3) and then solving for Ls1*
using equation (4). With the values of Ls1*, Ls1 and Ls0, we calculate the number of
jobs saved by the JCS as (Ls1*- Ls1). Following the definition of Calmfors (1994), the
cost of saving jobs, which is also known as the deadweight loss, is the wage subsidy
received by the firms for the workers that will keep their jobs even if there is no
subsidy. Therefore, the deadweight loss is (ws1*- ws1).Ls1. This deadweight loss is a
windfall received by firms because vulnerable workers cannot be easily targeted.
5. Data Specification
We group the required data to estimate equations (3) and (4) into three groups as
follows:
a. Production Function Parameters: α, β, γ
We obtained the parameters from earlier study of Singapore’s economy. The
parameters are factor cost shares in the Cobb Douglas case. Specifically, Young (1995)
using a Cobb Douglas production function showed that the labor cost share was 0.51,
and hence the assumed capital cost share was 0.49. Ho, Wong, Toh and Ping (2005)
obtained a labor cost share of 0.529. We assumed the capital cost share was 0.49,
which is γ = 0.49. We decomposed the labor cost share into two components. Given
that α + β + γ =1 for a Cobb Douglas function and αLs0 = βLf0, we could determine α
and β once γ was fixed.
b. Labor Inputs (Lf0, Ls0) and Wage Ratio (θ)
We used two sets of labor inputs (Lf0, Ls0) because there was no obvious way to
reconcile the discrepancies in official data. For the first set, we used the Labor Force
Survey data which was reported in the Yearbook of Statistics 2008 (Singapore
Department of Statistics, 2008). We used the number of local workers employed in
2007 to proxy for Lf0, and the Yearbook reported 1,842,100 residents were employed.
We used the total number of foreign workers employed in 2007 to proxy for Ls0. The
Yearbook did not report a direct figure. We subtracted the 1,842,100 resident workers
from the total employment of 2,670,800 to obtain 828,700 foreign workers employed
in 2007.
For the second set, we used the number of active CPF members from the Yearbook of
Statistics 2008 (Singapore Department of Statistics, 2008) to proxy for the number of
local workers. The number was only 1,545,000 in 2007. A discrepancy of about 19%,
between the number of local workers and the number of active CPF contributors, was
consistent with data from previous years. We removed the R pass holders from the
foreign workforce in the second set because restrictions prevented R pass holders
from competing in the local labor market. Yeoh (2007) estimated that there were
about 580,000 R pass holders. Therefore, we have two sets of Lf0, Ls0. The high
estimate was 1,842,100 local and 828,700 foreign workers. The low estimate was
1,545,000 local and 248,700 foreign workers
To find the wage ratio θ, where wf1*/ws1* =θ, we need wf1* and ws1* on a net basis. The
median gross wage was $2,500. The average monthly wage for CPF member’s
earning gross wage below $2,500 was $1,357 as shown earlier using table 4.
Therefore, the average monthly Jobs Credits would be $231, the average of 12% on
$2,500 and $1,357. The employer’s CPF contribution was 14.5% for most workers in
2007. Therefore, the net wage before the Jobs Credits would be $2,500*1.145 =
$2,862. This would be wf1*, the foreign worker’s net wage. After deducting the Jobs
Credits, local worker’s net wage, ws1*, would be $2,631. Therefore, the wage ratio
θ would be 1.088.
c. Change in GDP (Y1/Y0), Productivity (A1/A0) and Capital (K1/K0)
The Ministry of Trade and Industry forecasted the Singapore GDP to contract by 2%
to 5% in 2009 (MTI press release 29 Jan 2009). The Economist Magazine forecasted a
contraction of 7.5%, and there were speculations of a 10% contraction. At the peak of
the Great Depression, the US GDP contracted 18.2% net of inflation from May 1937
to June 1938. We created four scenarios based on these forecasts. In the optimistic
scenario, GDP contracted by 2%, the expected scenario had 5% contraction, the
pessimistic scenario had 10% contraction, and the catastrophic scenario had 20%
contraction.
Using Table 4.14 of the Yearbook of Statistics 2008 (Singapore Department of
Statistics, 2008) reproduced below, we found that the correlation between GDP
growth and capital growth was 0.473, and the correlation between GDP growth and
TFP growth was 0.324. We estimated the capital growth rate and TFP growth rate for
each scenario using the correlation with GDP growth rate.
Year %GDP Growth %Capital Growth %Labor Growth % TFP Growth
2002
4.1
1.7
-0.7
3.1
2003
3.4
1.4
-0.6
2.6
2004
8.6
1.7
0.8
6.1
2005
7.0
1.6
1.9
3.5
2006
7.9
2.1
2.9
2.9
2007
7.4
2.8
3.7
0.9
Table 4: Component of Singapore GDP Growth Rate for 2002 to 2007
In summary, we had four GDP growth forecasts, and in each forecast two estimates
for the size of the labor force, with θ = 1.088 and γ = 0.490, giving eight possible
scenarios. These scenarios are tabulated as follows:
Scenario Name
Ls0
Lf0
Y1/Y0 A1/A0 K1/K0 α
β
Optimistic, High 0.980 0.994 0.991 0.158 0.352 1,842,100 828,700
Expected, High
0.950 0.984 0.976 0.158 0.352 1,842,100 828,700
Pessimistic, High 0.900 0.968 0.953 0.158 0.352 1,842,100 828,700
Catastrophic, High 0.800 0.935 0.905 0.178 0.332 1,545,000 828,700
Optimistic, Low 0.980 0.994 0.991 0.071 0.439 1,545,000 248,700
Expected, Low
0.950 0.984 0.976 0.071 0.439 1,545,000 248,700
Pessimistic, Low 0.900 0.968 0.953 0.071 0.439 1,545,000 248,700
Catastrophic, Low 0.800 0.935 0.905 0.071 0.439 1,545,000 248,700
Table 5: Table of Parameters for the Scenarios
5. Result and Discussion
We summarized the numerical result, which forms the raw data for our analysis, in
Appendix A. The table below shows the job losses under the eight scenarios, with and
without the JCS, the number of jobs saved for local workers, and the ratio of number
of job saved to number of local job loss without JCS expressed in percentage.
Job Loss without JCS
Job Loss with JCS
Job Saved
Local Foreign Total Local Foreign Total Local Ratio
High Estimate
Optimistic
Expected
Pessimistic
Catastrophic
Low Estimate
Optimistic
Expected
Pessimistic
Catastrophic
32.4
82.0
167.7
350.0
14.6 46.9
36.9 118.9
75.4 243.1
157.4 507.4
-15.8
35.2
123.1
310.2
60.8 45.0
81.8 117.0
118.2 241.3
195.5 505.7
48.2
46.9
44.6
39.7
N.A.
57%
27%
11%
27.2
68.8
140.7
293.5
4.4 31.5
11.1 79.9
22.6 163.3
47.2 340.8
9.3
51.4
124.1
278.7
21.6 30.8
27.8 79.2
38.5 162.6
61.4 340.2
17.9
17.4
16.6
14.8
66%
25%
12%
5%
Table 6: Job Loss with and without JCS (in ‘000) by Group
We can draw three inferences by examining Table 6. First, the effects of the JCS on
total employment is small: comparing total job loss with and without JCS shows
savings of less than 2,000 jobs using the Labor Force Survey data in the High estimate,
and less than 1,000 jobs using the CPF data in the low estimate. For example, if the
economy shrinks by 2% (Optimistic) and using the data from the Labor Force Survey
(High), the total job loss is nearly 47,000 without the JCS and nearly 45,000 with JCS,
giving a reduction slightly less than 2,000 jobs. Second, despite the small effect on
total employment, the JCS has a clear substitution effect shifting the job loss to the
foreign workers. In fact, in the “Optimistic, High” scenario, the demand for local
workers increases more than 15,000 while foreign workers faced a job loss of more
than 60,000. If the JCS has not been implemented, the local workers would face a job
loss of more than 32,000, and foreign workers would have a smaller job loss of less
than 15,000. The “Optimistic, High” scenario is an unusual case where there is net job
gain for local workers. Third, job loss increases rapidly with economic contraction,
but the job saved by the JCS decreases slowly. Therefore, the effectiveness of the JCS
in reducing job loss, which is measured by the ratio of number of job saved to number
of job loss without JCS, decreases as the economic contraction becomes more severe.
For example, accounting for the fact that R pass holder cannot enter the local labor
market and hence using the “Low Estimate”, we can see that there is decreasing
effectiveness: 66% of the job loss is saved by JCS if the economy contracts by 2%,
25% if the contraction is 5%, 12% if the contraction is 10%, and 5% if the contraction
is 20%. The “High Estimate” data has an anomaly that there is actually job gain for
local worker in the 2% contraction scenario. Next, we explore the question on the
economic cost of the JCS using the following table:
Job Saved DWL Spend %DWL
High Estimate
Optimistic
Expected
Pessimistic
Catastrophic
Low Estimate
Optimistic
Expected
Pessimistic
Catastrophic
48,184
46,862
44,581
39,728
5,026
4,888
4,650
4,144
5,159
5,018
4,774
4,254
97.4%
97.4%
97.4%
97.4%
17,928
17,436
16,587
14,782
4,215
4,099
3,900
3,475
4,265
4,148
3,946
3,516
98.8%
98.8%
98.8%
98.8%
Table 7: Job Saved, Deadweight Loss (DWL) in S$m, JCS Spending in S$m under eight Scenarios
We can draw two inferences from Table 7 above. First, the JCS spending exceed the
budget of S$4.5 in the “High Estimate” for most cases, but is within budget for the
“Low Estimate”. Given that the administration of JCS is tied to CPF payment, “Low
Estimate” is more likely to occur. Second, most of the spending would become
deadweight loss, which is a windfall to firms. Therefore, the scheme effectively
becomes a corporate tax credit with three differences from the traditional one: First,
there is a substitution effect on the choice of labor between local and foreign workers.
Second, the stimulus is administered in quarterly installments instead of one lump
sum at the end of the financial year. The effect of the JCS is therefore quicker and
could save firms on the verge of bankruptcy. The economic cost of bankruptcy would
consist of the loss of firm specific human capital and the worker’s search cost for the
placement in a new job. Third, the benefit would accrue primarily to labor intensive
industries rather than profitable firms. The size of the JCS stimulus to the firm would
be ten times as large as the $0.5b corporate tax cut from 18% to 17% in the Resilience
Package.
6. Limitation
There are two limitations in our model that arise mainly due to the lack of available
data. First, we have modeled the economy as one big firm. Our result would be the
same if the economy comprises many homogeneous firms, but this scenario is
unrealistic. Modeling heterogeneous firms is an area of further research. Second, our
model is static, while reality is dynamic. A dynamic model would have smaller job
losses in economic contractions compared to our model, and therefore smaller effect
of the JCS. In other words, the actual job loss may be less severe than our model’s
prediction. The following figure explains the rationale:
Is o q u a n t 2
Lf
Is o q u a n t 1
A
C
X
E
Y
B2
Z
Ls
F
B1
D
Figure 2: A Dynamic Model with Rehiring Cost
Suppose isoquant 1 is the long run equilibrium and the initial isocost line is AB1 in
Figure 2 above. The firm maximizes profit by using the combination of labor at X,
and the isocost AB1 is tangent to isoquant 1. In view of the economy contracting to
isoquant 2, the government implemented JCS, which shifted the isocost line to AB2.
In our static model, we argue that a new equilibrium is established at Z, the new
tangent of the isocost EF and isoquant 2.
However, in a multi-period model with positive cost for firm to rehire workers when
the economy recovers, a profit maximizing firm may not choose Z. If the firm chooses
Y, it responds to the incentive in JCS to change the labor mix, but uses more labor
than needed to produce the output for isoquant 2. The perpendicular distance between
isocost lines CD and EF is the cost of inefficiency in the current period. If the cost of
this inefficiency is smaller than the time discounted cost of rehiring in the next period,
the firm is better off choosing Y than Z. If the rehiring cost is even higher, the firm is
better off not changing the worker mix and stays at X. So, what is the cost of rehiring?
There is a smaller direct cost of rehiring in the recruitment process. There is a larger
indirect cost that arises from training and accumulation of human capital and social
capital. Becker (1962) argues that firm-specific human capital (FSHC), where the
investment is worth less when the worker joins another firm, should be jointly
invested by the firm and the worker. The worker invests by accepting a wage lower
than his alternative wage during training and receives a return from a wage higher
than his alternative wage after training. The firm invests by paying a wage higher than
the worker’s marginal product during training and receives a return from by paying a
wage lower than the worker’s marginal product after training. Parsons (1972) argues
that large investment in FSHC causes worker-job separation to be costly and reduces
labor mobility. Since the worker’s wage is below his marginal product after training,
the firm will not lay off the worker during a minor demand decline because the firm
will suffer a capital loss. Retrenching worker has also a powerful and negative effect
on the surviving workers. Firms can choose to reduce wage cost by other means, such
as mandatory unpaid leave or temporary wage cut, instead of retrenching workers.
This is not an altruistic motive but arises because of rehiring cost. Hence, our model’s
prediction of job loss is bias upwards.
7.
Conclusion
In conclusion, the JCS is effectively a fast-acting corporate tax cut that favors firms
with large labor force. It has a substitution effect that can save 5% to 66% of the local
workers from job loss that would have occurred without it, but JCS is less effective in
more serious economic contractions. Our model’s prediction of job loss is bias
upwards for two reasons. First, rehiring cost in the more realistic multi-period models
can cause profit maximizing firms to retain workers and suffer temporary inefficiency
when rehiring cost is high enough. Second, firm can use temporary measures, such as
mandatory unpaid leave and wage cut, to reduce wage costs instead of retrenching and
incurring rehiring cost in a later period.
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Appendix A: Outcome of the Scenarios – Job Saved, Deadweight Loss and Budget Size
Scenario Names
Budget
Ls0
Lf0
Ls1
Lf1
Ls1*
Lf1* Job Saved Deadweight Loss
Optimistic, High Labor 1,842,100 828,700 1,809,721 814,134 1,857,905 767,942
48,184 $5,025,667,082 $5,159,475,634
Optimistic, Low Labor 1,545,000 248,700 1,517,843 244,329 1,535,771 227,141
17,928 $4,215,110,820 $4,264,896,331
Expected, High Labor
1,842,100 828,700 1,760,066 791,796 1,806,928 746,872
46,862 $4,887,774,657 $5,017,911,819
Expected, Low Labor
1,545,000 248,700 1,476,197 237,625 1,493,633 220,908
17,436 $4,099,458,143 $4,147,877,658
Pessimistic, High Labor 1,842,100 828,700 1,674,397 753,256 1,718,978 710,519
44,581 $4,649,868,686 $4,773,671,593
Pessimistic, Low Labor 1,545,000 248,700 1,404,345 226,059 1,420,932 210,156
16,587 $3,899,922,436 $3,945,985,195
Catastrophic, High Labor 1,842,100 828,700 1,492,143 671,266 1,531,872 633,180
39,728 $4,143,741,818 $4,254,069,080
Catastrophic, Low Labor 1,545,000 248,700 1,251,486 201,453 1,266,267 187,281
14,782 $3,475,425,388 $3,516,474,328