In-Work Benefits and the Nordic Model

Abstract Welfargon benets in the Nordic countries are lots laced to profession. We manage that this is unmatched of the bad-temperedors behind the success of the Nordic example, where a comprehensive wellbeing say is associated with gritty employment. In a prevalent residual setting, the underlining mechanism works by wage moderation and affair launching. The benets make it more cardinal to hold a job, thus demean wages will be accepted, and more jobs created.Moreover, we show that the incentive to embrace high culture improves, further boosting employment in the ample run. These verifying eects help counteracting the disallow impact of imposeation. JEL codes H24, J21, J24 Keywords Nordic model, in-work benets, wage adjustment, unemployment, statement, dexterity formation, earnings 1 Introduction A prominent feature of the supposed Nordic model is a comprehensive welfare state nanced by tax incomees on motor.In fact, the public sector in umteen We want to thank Torben Andersen, Martin Floden, Richard Freeman, Mathias Herzing, Eddie Lazear, Ethienne Lehman, Bruno van Linden, and participants at the Conference on the sparing science of the Nordic Model. y Department of Economics, Stockholm University, S-106 91 Stockholm, Ph. +46 8 163547. Fax +46 8 161425, E-mail address ann-soe. emailprotected su. se z Economics Division, University of Southampton, UK Economics Department, UniCredit & Universities Fellow, Central European University, Budapest and IZA, Bonn.Email address m. emailprotected ac. uk 1 of the Nordic countries is liable for the distribution and allocation of resources amounting to more than half of their country GDP (Eurostat, s 2012). With an emphasis on redistributional transfers and service provision nanced by taxes on labor, a concern with the model is, of course, that it induces weak incentives to work. In a more colossal status perspective, such a system may in any case flash back incentives to acquire attai nments, with a negative impact on future pproduactivity and labor commercialise outcomes.However, external observers are often surprised that the Nordic countries talk terms to combine low unemployment and high labor ram mesh with high taxes and generous welfare arrangements. So, how is this possible? One answer to this question is that many of the welfare arrangements in the Nordic countries are closely tied to market work. The generosity of the benets are, in general, related to earnings. In addition, eligibility to a number of benets and genial services is qualified on employment.Subsidized childcare, for example, is, in principle, only available to busy workers. Also, some generous elements of the paid parental leave schemes are only favorable to utilize workers. In addition, the more recently introduced earned income tax consultation is by denition exclusively targeted to employed workers. The idea is that these benets, by increasing the returns from working, improv er the come forth of labor. The observation that the Nordic countries have sustained high economic aactivity because benets are closely tied to market work is non new.In fact this was noted as a contributing factor to the high participation rate observed in Sweden when a group of NBER economists studied the Swedish welfare state in the mid 1990s (see Freeman et al. , 1997). This was also an important message in the discussion on the prospects and challenges of the Scandinavian model in Andersen (2008). The starting point for this paper is that entitlement to many of the benets available in the Nordic countries is conditional on employment. As discussed above, this tends to increase the gains from working, which encourages labor supply.However, we argue that this is not the end of the story. To investigate the full impact of welfare state arrangements of this type, one needs to account for the general equilibrium eects. This is peculiarly relevant because many benets have been ava ilable to the whole population for a long period of time. Clearly, to investigate the eects of these benets on employment, which is an equilibrium outcome, both(prenominal) supply-side and demand-side factors must be iincluded in the analysis. Moreover, beside considering the equilibrium outcome for the existing workforce, it is important to account 2 or the impact of these benets on incentives to acquire skills. The equilibrium composition of the workforce in terms of educational attainment is a crucial variable for the sustain capacity of the Nordic model, both in terms of its ripening potential and international competitiveness (Andersen, 2008) and in terms of the political incite for the welfare state (Hassler et al. , 2003). To carry out such an analysis, we develop a simple model of a non-clearing labor market featuring involuntary unemployment as an equilibrium outcome.Labor force participation is also endogenously determined. Moreover, individuals dier in their ability to acquire education and choose educational attainments based on a cost-benet analysis. In particular, we focus on the choice between action to higher, i. e. tertiary, education or not. The aim is to investigate the implications of benets that are conditional on work on unemployment and labor force participation, accounting for their long term impact on educational attainments.We show that benets available only to employed workers moderate wages, reduce unemployment rates, and increase labor force participation and employment. Moreover, one could expect that welfare benets, even if conditional on work, could induce an straight-out reduction in education as they represent an important subvention for low skilled workers. What we nd instead is that the incentives to proceed to higher education are actually strengthened. This is a consequence of the relatively sthronger increase in labor market opportunities for highly educated workers that follow when wages are moderated.Wages, in tur n, fall because workers are more willing to accept begin wages when benets are conditional on work and thus the rate of having a job is higher. Lower wages increase job creation and lower the unemployment rate. Thus, total employment increases for three sets of reasons. First, the benets reduce the unemployment rate for workers at all educational levels. Second, more workers choose to proceed to higher education where expected unemployment spells are shorter. Third, as labor force participation increases with the benets, a larger share of the population will be employed.We also assist at the impact of benets when they are nanced through a proportional tax on wages. Taxation actually reinforces wage moderation and, as such, does not overrule that benets reduce wages, increase job creation, and reduce unemployment rates. However, it weakens the incentives to acquire higher education and participate in the labor force, thus inducing a counteracting eect on educational attainment and labor force participation. The element of the Nordic model that this paper underlines is the wage moderation stemming from benets conditional on work.Also, we nd this 3 mechanism to be very fertile to the choice of model. Moreover, looking at benets through this channel highlights how they have a overconfident impact on educational attainment and participation, thus counteracting, at least partly, the negative eect that taxation has on skill acquisition and labor force participation. The analytical results are followed up with a numerical example illustrating the eects of the benets on labor market mental process and educational attainment.The simulations indicate that benets can have an important impact on unemployment for both low- and high- skilled. Without distortinary taxation, benets also have a positive impact on skill acquisition, thus further reducing overall unemployment in the long run. When nancing through proportional taxation on wages is iincluded in the model, the negative eect of taxation on educational attainment dominates the positive eect of benets, thus resulting in a decrease in the share of the workforce acquiring tertiary education.Nonetheless, benets still have a positive overall impact on unemployment. Considering the previous literature, there are a number of studies that have tried to explain why the Nordic countries have performed so well despite high taxes and generous welfare arrangements. As mentioned, some of these studies have emphasized the importance of that benets are tied to market work for the successful outcome in terms of employment and participation (see Aronsson and Walker, 1997).A related view is provided by Rogerson (2007). He argues that the governmentsspending formula in the Scandinavian countries, compared to other high tax countries, can potentially explain the large number of aggregate work hours observed in these countries. He shows, holding tax rates constant, that it matters if the revenue is spent on di sability payments which may only be received when an individual does not work or subsidies for day care for working mothers. The reason is that childcare subsidies create jobs.Our study also nds that how the government choose to spend tax revenues matters for labor market performance, although for a dierent reason. In railway line to Rogerson (2007), our results materialize through general equilibrium eects working through wage moderation. there is also a large number of studies focusing on particular features of the welfare state in the Nordic countries, looking for instance at the impact of childcare subsidies and paid parental leave schemes on labor supply and a number of other outcome variables. 1 In contrast to our study, this literature