76212 Active Labor Market Programs: How, Why, When, and to What Extent are they Effective? Introduction Alessio J.G. Brown and Johannes Koettl The global economic crisis has had a substantial impact on 1 labor markets in both industrialized and developing Key Messages economies. Both witnessed massive layoffs as well as reductions in wages and hours worked, and thus significant  Active labor market programs (ALMPs) aim to keep increases in unemployment and poverty. Although workers employed, bring them into employment, economic recovery is on its way, the job crisis will persist increase their productivity and earnings, and for some time yet. As experienced in previous crises, improve the functioning of labor markets. employment growth will lag behind and not suffice to  ALMPs to retain employment – for example, work- accommodate the high unemployment, leading to longer sharing schemes – should be used only for short unemployment spells, higher long-term unemployment, and periods during severe recessions. More cost-effective eventually skills attrition, thereby negatively affecting and useful during recoveries are ALMPs to create future employment prospects. employment, which strengthen outsiders’ labor market attachment and support the outflow out of Figure 1: ALMP Expenditures (% GDP) and unemployment. % of GDP Unemployment Rates %  In-work benefits and public works are not cost 0.80 16.00 effective in raising employment, but possibly work to 0.70 14.00 0.60 12.00 reduce poverty and inequity. Policies that readjust 0.50 10.00 distorted employment incentives, such as activation 0.40 8.00 and sanction measures, have delivered cost-effective 0.30 6.00 results. 0.20 4.00 0.10 2.00  Training programs are especially effective over the 0.00 0.00 long term, particularly the more they target disadvantaged outsiders. ALMPs that improve labor market matching are highly beneficial, but effective only in the short run. ALMP 2010 UR 2010 UR 2012  ALMPs in general might be more cost effective over the long term (3–10 years) and some may even be Source: For selected ECA countries, expenditures on ALMPs (% of self-financing, suggesting that long-term evaluations GDP) according to the Eurostat Database and unemployment rates based are needed to better ascertain the impact of on the ILO Database; OECD averages according to OECD Database, individual policies. October 2012. Active Labor Markets Programs (ALMPs) have been heavily advocated by the Organisation for Economic Co- 1 This brief is based on A. J. G. Brown and J. Koettl, “Active Labor operation and Development (OECD) and are of growing Market Programs - Employment Gain or Fiscal Drain?� IZA Discussion interest and relevance to transition and developing Paper 6880 (Bonn: Institute for the Study of Labor (IZA), 2012). The countries. In contrast to passive labor market policies, such results and insights discussed here are based primarily on studies mainly from OECD countries. as unemployment insurance and transfers to provide income replacement, active policies increase and enhance labor ECA Knowledge Brief supply, increase labor demand, and raise the efficiency of during off-hours to support skills development;2 and (ii) labor market matching. Although many Europe and Central measures to support outsiders whose positions are Asia (ECA) countries have been introducing ALMPs in significantly weakened. At the same time, the appropriate response to the economic crisis, the ECA region is lagging design of these ALMPs and the adaptability of existing behind in the adoption of these measures relative to OECD minimized programs are crucial. averages (see figure 1). The unemployment rates in ECA The usefulness of this category ALMPs is of limited countries, as well as tighter budget constraints and deficits, duration, however, due to the risks associated with highlight the need to encourage these countries to invest increasing labor market persistence, long-term further in cost-effective ALMPs to support their recovery. unemployment from having disadvantaged outsiders, and A New Perspective on ALMPs delaying inevitable labor reallocation, any or all of which might also obstruct recovery. Presented here is a new perspective to bridge the gap between understanding the value of cost-effective ALMPs Incentives to Create Employment (Category II) and working to boost recovery. The different types of ALMPs that promote the creation of employment involve ALMPs are classified in terms of their primary target: mainly financial incentives – for example, subsidies for Category Instruments employers, grants and credits, and entrepreneurship I. incentives to retain work sharing and short work and advisory services encouraging start-ups. As noted above, employment wage subsidies wage subsidies3 are cost ineffective, due to the significant II. incentives to create wage and hiring subsidies, start- and undesirable indirect effects, including the long-run employment up support negative implications for skills development. III. incentives to seek and in-work benefits, subsidies, tax Conversely, for a limited period, hiring subsidies to private keep a job credits, public works, activation employers can indeed be cost effective and have sizeable and workfare, sanctions macroeconomic employment effects.4 However, such IV. incentives for human on-the-job and classroom training measures should be sensibly targeted in order to balance capital enhancement negative effects and employment impacts. To maximize the V. improved labor market job search assistance, employee- positive labor market outcomes (as well as the competition, matching employer intermediation services, transition,5 and screening effects), hiring subsidies should counseling, and monitoring be targeted at the losers in the labor market, for example, the long-term unemployed and inactive workers. Moreover, Incentives to Retain Employment (Category I) to increase cost effectiveness, subsidy payments should continuously increase as unemployment endures. ALMPs that offer incentives to safeguard employment via subsidies to employers or work-sharing schemes aim to Even if the positive and negative consequences of these support or increase labor demand and thereby prevent lower measures cancel each other out and result in no increase in employment after a fall in economic activity. Wage total employment, hiring subsidies may still be desirable. subsidies, however, are subject to substantial deadweight By redistributing employment incentives to the and displacement costs and tend to put upward pressure on disadvantaged, strengthening the latter’s attachment to the wages; they have also proven to be cost ineffective, and labor market and thereby reducing long-term unemployment have not provided the incentives needed to retain workers. (at the cost of increasing short-term unemployment), hiring subsidies increase labor market flows, reduce labor market Work-sharing arrangements, on the other hand, if applied persistence, and enable a more equitable distribution of for a limited period of time at the onset of a severe unemployment. Hiring subsidies can also be a significant economic crisis, may alleviate the crisis’ impact on countercyclical labor market stabilizer in ordinary times to employment, when the outflow from unemployment is avoid increases in long-term unemployment and likely to drop significantly in any case. One example is the detachments from the labor market. German “Kurzarbeit� scheme, whose success at keeping unemployment down has generated interest in these programs as a tool to combat economic crises. Work- sharing schemes enable employers to reduce labor costs and 2 Skills training is also needed to counteract the increase in at the same time retain skilled employees with full or partial unemployment-prone labor market groups due to the disincentives for preservation of their income. Importantly, these cost- skill acquisition inherent in these measures. intensive schemes should be combined with: (i) training 3 They target all employed workers of a specific skill-class or sector. 4 Strong evidence for this exists, especially in Sweden. 5 By bringing workers back to work, their human capital appreciates, which increases their retention and, if fired, their reemployment probability. These effects are evidenced in German hiring subsidies. ECA Knowledge Brief In response to the recent crisis, various OECD countries incentives, financial transfers to unskilled workers can be an have adopted hiring subsidies targeted at disadvantaged effective redistributive tool to soften income shortfalls. elements of the workforce (the long-term unemployed, the Similarly, public works programs are also something of a disabled, younger and older workers) as well as reductions fiscal drain and can even have negative effects on in non-wage labor costs for hires. Though these instruments participants’ later employment prospects. The evidence on can be cost ineffective once an economic crisis hits and the ineffectiveness of public works has been widely labor demand plummets, they are also an important way to documented: they neither enhance the labor supply nor support the recovery once it is in sight and to incentivize the promote adaptability in the labor market. During crises, recruitment of disadvantaged workers. In any case, during a however, the temporary use of such programs targeting poor recession, the equity aspect might be relevant to prevent families is justified as a means of combating poverty by disadvantaged workers from leaving the labor market and providing a safety net. In middle-income countries, where give them a competitive edge in the search for jobs. existing safety nets cannot be expanded swiftly, ready Targeting should be tightened once the recovery accelerates public works schemes can provide a needed cushion, or in to reduce costly negative indirect effects. low-income countries, where safety nets are broadly ALMPs that offer incentives for self-employment are nonexistent, public works can offer an employment of last smaller in size and applicability and involve financial and resort. advisory support. Besides the direct objective of supporting However, the combination of public works instruments with the outflow of workers from unemployment into self- activation policies such as workfare has shown positive employment, these programs’ indirect desired outcome is results, especially due to the significant threat effects. For the additional employment created by the start-ups. example, within the rights and duties framework of the Recent evidence confirms the positive impacts of providing unemployed, the introduction of workfare has been incentives for self-employment, even though its particularly effective in Denmark’s “flexicurity� set of applicability is limited to a small fraction (up to 3 percent) policies. In general, sanctions and activation measures have of the unemployed workforce. Advisory services on their been very successful in restoring search and work own or combined with financial incentives generally incentives; moreover, imposing such measures with generate better results than financial incentives alone. A requirements to participate in job search assistance, training, recent evaluation of two German self-employment subsidies or subsidized employment might also be more cost-effective shows that the programs lead to significantly higher income alternatives in light of the considerable locking-in effect of for participants after five years, and a 20 percent higher public works. employment probability. Due to their generally low employment prospects, self-employment subsidies are Human Capital Enhancement (Category IV) especially effective for the disadvantaged workers in the ALMPs that provide incentives for human capital labor market, namely the young, low-skilled, long-term enhancement, such as on-the-job or classroom training, are unemployed, and inactive workers, as the subsidies boost widely used and represent the largest share of governments’ their labor market attachment and adaptability to labor expenditures on such programs. Evaluations of these market conditions and thereby support recoveries. ALMPs, however, show mixed results. Their high cost often leads to “cream-skimming,� for example; since case Incentives to Seek and Keep a Job (Category III) workers must demonstrate a high rate of success with the This category includes measures that address labor supply transition into regular employment, they may chose by increasing the payoff of employment for workers, either unemployed workers with higher employment prospects, by raising the return from employment or making thereby increasing the deadweight effects. unemployment more costly. Financial transfers to workers Training can substitute for work experience. To maximize and public works programs do not target employment the screening and transition effects, based on the available exclusively but are aimed also at reducing inequality and in- evidence it is clearly important to orient the training work poverty. towards the current and future skills needs of employers, Financial transfers to workers are not cost effective, and due who should be actively involved. In addition, such training to various disincentives, they have no (longer-run) positive should provide recognized formal qualifications and be employment effects, though under certain conditions, they available on-the-job, which has proven to be more effective might prove to be cost-effective redistribution policies. than classroom training. Evidence from some European These transfers fail especially because of their implicit aim countries shows that adding on-the-job to classroom of supporting the unskilled in work without promoting their training increases the probability of a positive impact by 30 adaptability. Still, if applied temporarily in crises within a percent. Training measures involve strong locking-in package of instruments that also address demand-side effects, however, whose magnitude is directly related to ECA Knowledge Brief program duration, and empirical evidence suggests that the Policy Implications reduced employment prospects during participation may even outweigh the benefits. Such results, though, are driven This brief presented a new perspective on categorizing by the locking-in effect and a focus on the short term. ALMPs and assessed their cost effectiveness. It is important to stress that longer-run evaluations of ALMPs are essential Positive outcomes generally need one–three years to to further measure their value, as the various ALMPs have materialize. Recent findings in Germany and the United different application advantages: States, as well as in meta-studies, demonstrate that the effectiveness of training programs increases significantly in Cat. Policy Cost Effectiveness the medium to long term and that the short-term ranking of I. Work sharing / Very costly and potential negative policy effectiveness can be reversed. In fact, evidence Short work longer-term impacts. Only useful for a limited time for existing schemes at suggests that these measures increase employability and onset of severe recessions. earnings in the long run. Thus, although costly, on-the-job I. / Wage subsidies Cost ineffective and potential negative training targeted at long-term unemployed workers seems to II. longer-term impacts. be cost effective, due to the implied competition, screening, II. Hiring subsidies Cheapest and most cost-effective and transition effects. To keep the long-term unemployed measure. As automatic stabilizer, target attached to the labor market and upgrade their skills, these disadvantaged, especially long-term measures might also be relevant in recessions, though with unemployed worker for limited period. little or no short-term impact. Self-employment Cost effective, but restricted incentives applicability. Improved Labor Market Matching (Category V) III. In-work benefits Cost ineffective: costly and no long-run and subsidies positive employment effects. ALMPs that improve labor market matching are widely Cost-effective redistribution policy in used in OECD countries, inexpensive, and effective in crises, but targeting Issues. increasing the efficiency of search and match efforts. These Public works Cost ineffective: costly and no long-run positive employment effects. measures are targeted mainly at outsiders and thus present However, safety net role in crises. competition to insiders and weaken their position. Evidence Activation and Cost-effective policy in shifting toward from Denmark, Romania, and the United Kingdom, for workfare active income support. example, shows the significant benefits of intensified job Sanctions search assistance for outsiders on their employment IV. On-the-job On-the-job-training targeted at long-term prospects and sometimes earnings, especially for long-term training unemployed workers particularly cost- unemployed workers. The outflow from unemployment Classroom effective in the long-run. training increases between 15 and 30 percent in OECD countries. Job search Cost-effective policy, essential for labor While these effects are achievable very swiftly in contrast to assistance market functioning with short-run impact. other ALMPs, their effectiveness is concentrated in the Employer inter- Search assistance proven strong impacts short run and is not as sustainable. mediation service on employability, especially for Counseling, disadvantaged workers Evidence from Germany underlines the argument that job monitoring search assistance should be targeted at unemployed workers with low hiring prospects to help them avoid long-term Overall, ALMPs can have a positive impact, albeit modest, unemployment, and beyond that, at long-term unemployed but may be desirable even if the impact is not on net workers. Recent studies confirm that ALMPs to improve employment. The evidence and lessons learned from job matching should be implemented at the beginning of the various developed countries will be instrumental in helping unemployment spell. The literature shows that ALMPs to the ECA countries catch up on ALMP expenditures and improve labor market matching are very cost effective and other ongoing efforts to promote employment in the post- can have significant short-run outcomes. The targeting crisis recovery. minimizes the negative consequences, and potential About the Authors: churning incentives can be avoided with sanction Johannes Koettl is a senior economist in the Human mechanisms. While these ALMPs are essential to the Development Sector Unit of the Europe and Central Asia general functioning of the labor market, they are most Region of the World Bank. Alessio J.G. Brown is a senior effective during recoveries, as they reduce the extent to research economist at the Kiel Institute for the World which employment growth lags behind. Economy and a senior consultant at the World Bank. “ECA Knowledge Brief� is a regular series of notes highlighting recent analyses, good practices, and lessons learned from the development work program of the World Bank’s Europe and Central Asia Regio n http://www.worldbank.org/eca