Revenue-sharing Subsidies as Employment Policy: Reducing the Cost of Stimulating East German Employment

This paper provides a brief overview of the East German employment problem and presents a simple model in which to evaluate two rival policy proposals: wage subsidies and revenue-sharing subsidies. Revenue-sharing subsidies have received little, if any, attention in the ongoing public debate on how to raise East German employment efficiently. This paper suggests that this may be a serious omission. Given the labour market conditions in East Germany today, it is shown that the social and budgetary costs associated with revenue-sharing subsidies may be expected to be lower than those associated with wage subsidies. The intuition underlying this result is that given the structure of wage bargaining in East Germany, wage subsidies may be expected to lead to excessive real wage increases, whereas revenue-sharing subsidies may not. The reason is that revenue- or profit-sharing may be expected to bring the labour market close to full employment even when the associated subsidies are negligibly small, and thus these subsidies can be devoted entirely to the achievement of the government's wage targets. By contrast, negligibly small wage subsidies cannot generate full employment under current East German labour market conditions, and subsidies that are sufficiently large for this purpose may be expected to drive real wages far above the government's wage objectives.