^*Marcello Estevão is a senior economist with the Western Hemisphere Department of the IMF. The author thanks Raphael De Coninck for excellent research assistance. Insightful comments were provided by Xavier Debrun, Eric Dubois, Luc Everaert, Robert Flood, David Grubb, Timothy Lane, Frederic Lerais, two anonymous referees, and seminar participants at the French Ministry of Economy. David Grubb and Laura Bardone promptly answered many questions on the data from the Organization for Economic Cooperation and Development (OECD).

Abstract

Using panel data for 15 industrial countries, active labor market policies (ALMPs) are shown to have a positive effect on employment rates, after controlling for institutional variables and country-specific effects. Among such policies, direct subsidies for job creation were the most effective. This paper shows that ALMPs raise employment by improving labor market functioning: higher expenditure on ALMPs is associated with lower wages for given levels of the unemployment rate. Whether ALMPs are cost-effective from a budgetary perspective remain to be determined, but they are certainly not substitutes for comprehensive institutional reforms. In particular, if higher expenditures on ALMPs are financed through increased labor income taxation, it could have deleterious effects on labor utilization.