In this blog, we look at the potential of wage subsidies for supporting jobs and incomes during the COVID-19 (Coronavirus) crisis. The crisis affects both workers’ ability to go to work and the labor demand of firms that are forced to close. The International Labour Organization (ILO) estimates that COVID-19 could increase global unemployment by up to 25 million (an increase of 13% compared with 2019). The estimates remain highly uncertain, but policy responses are clearly needed. So, what can be done to protect workers and lessen this impact?
The long-term economic costs of allowing the crisis to destroy good job matches are potentially high and laid-off workers could face protracted unemployment. To stop that from happening, wage subsidies can partially or fully cover wages and other payroll costs, such as social security. Past experience during economic downturns suggests that wage subsidies can indeed help avert job destruction (here and here).
During the COVID-19 crisis many countries have already put in place generous wage subsidies, often combined with flexibility in work arrangements. In Austria, a temporary work compensation scheme (“Kurzarbeit”) allows employers to pay only for actual time worked, with the government paying for the remaining work hours, including taxes and contributions. In Germany, a similar scheme, subsidies amount to 60 percent of loss after-tax wages (67 percent if the employees have at least one child) plus social security contributions. Businesses can register with the scheme if 10 percent of their employees face income disruptions of more than 10 percent due to the current crisis. In Denmark, Italy, and the UK, employees of companies that have interrupted activities will collect most of their salary from the state (90% in Denmark; 80% in Italy and the UK). In Thailand, SMEs can deduct from taxes three times the amount paid in salaries to employees affiliated to the Social Security Office, up to 15,000 baht/person/month, conditional on maintaining employment levels.
Well-known concerns about the economic efficiency effects of wage subsidies are less salient when they are used counter-cyclically. The deadweight losses that arise when firms retain workers whose productivity is below the market wage are offset by the avoidance of social costs from high unemployment and of the negative spillover effects from unemployment on workers’ future productivity. Windfall wastage, that happens when a subsidy supports workers who would have been hired or retained in any case, will also be less likely, given the contraction in aggregate labor demand. Substitution effects linked to the replacement of some workers by others are also less likely, when subsidies are tied to a firm’s pre-crisis employment level and in a setting where firms want to avoid losing their investments in firm-specific human capital.
Four key design considerations can help ensure the effectiveness of wage subsidies in the COVID-19 crisis. First, the subsidies need to be sizeable, to ensure high take-up and encourage large-scale worker retention. Second, subsidies need to be (at least temporarily) conditioned on workers’ retention and/or flexible work arrangements. Third, countries that plan to set up a subsidy scheme should start preparations quickly as setting one up takes time. Fourth, this needs to be a temporary measure, linked to the crisis. When normal business hours resume the subsidy scheme should be wound down, to avoid firms keeping workers on reduced hours for too long.
A key limitation of wage subsidies is that they usually cover only formal wage workers and the registered self-employed. Having a counter-cyclical wage subsidy policy in place may increase the incentives for informal firms and workers to register themselves, so they can qualify in the future. In the meantime, the best way to quickly support informal wage workers and the informal self-employed is through cash transfer and social assistance systems, whose scope and benefit amounts can be quickly expanded when there are mechanisms in place to identify and register beneficiaries, such as social registries.
In our next blog, we will expand on the crucial role of safety nets for protecting informal workers and their families in the face of the COVID-19 crisis, especially in Low-Income Countries (LIC) settings.
This is the second blog on ways to protect workers and jobs in the COVID-19 (Coronavirus) crisis, based on a World Bank Jobs Group Note: “Managing the Employment Impacts of the COVID-19 Crisis, Policy Options for the Short Term.” Over this week we will issue blogs covering: supporting firms; wage subsidies; and safety nets for informal sector workers. In the following weeks, we’ll look at the role of unemployment benefits; active labor market programs; and public works programs that use digital technologies.