The Political Economy of Labor Subsidies

24 Pages Posted: 7 Dec 2012

See all articles by Marina Azzimonti

Marina Azzimonti

SUNY Stony Brook - Department of Economics; National Bureau of Economic Research (NBER)

Eva de Francisco

CUNY Lehman College

Per Krusell

Princeton University - Department of Economics; Stockholm University - Institute for International Economic Studies (IIES); Centre for Economic Policy Research (CEPR)

Date Written: September 1, 2006

Abstract

We explore a political economy model of labor subsidies, extending Meltzer and Richard's median voter model to a dynamic setting. We explore only one source of heterogeneity: initial wealth. As a consequence, given an operative wealth effect, poorer agents work harder, and if the agent with median wealth is poorer than average, a politico-economic equilibrium will feature a subsidy to labor. The dynamic model does not have capital, but it has perfect markets for borrowing and lending. Because tax rates influence interest rates, another channel for redistribution appears, since a decrease in current interest rates favors agents with a negative (below-average) asset position.

By the same token — and as is typically the case in dynamic politico-economic models with rational agents — the setting features time-inconsistency: the median voter would like to commit to not manipulating interest rates in the future. Under commitment, and under the assumption that preferences admit aggregation, we show that labor subsidies subsist only for one period; after that, subsidies are zero. That is, under commitment, the median voter takes advantage of the voting power once and for all. His wealth moves closer to that of the mean (which is zero), but afterwards he refrains voluntarily from further subsidization. Under lack of commitment, which we analyze formally by looking at the Markov-perfect (time-consistent) equilibrium in a game between successive median voters in the same environment. Instead, subsidies persist — they are constant over time — and are more distortionary than under commitment. Moreover, in the situation without commitment, the median voter does not manage to reduce asset inequality, unlike in the commitment case.

Keywords: commitment, median voter theorem, Markov equilibrium, time consistency, labor subsidies, aggregation

JEL Classification: E61, E62, H11, H29, H41, O23

Suggested Citation

Azzimonti, Marina and de Francisco, Eva and Krusell, Per L., The Political Economy of Labor Subsidies (September 1, 2006). FRB Richmond Working Paper No. 06-09, Available at SSRN: https://ssrn.com/abstract=2186156 or http://dx.doi.org/10.2139/ssrn.2186156

Marina Azzimonti (Contact Author)

SUNY Stony Brook - Department of Economics ( email )

NY 11733-4384
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Eva De Francisco

CUNY Lehman College ( email )

Per L. Krusell

Princeton University - Department of Economics ( email )

111 Fisher Hall
Princeton, NJ
United States
609-258-4003 (Phone)
609-258-6419 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden
+46 0 8 16 30 73 (Phone)
+46 0 8 16 41 77 (Fax)

HOME PAGE: http://rincewind.iies.su.se/%7Ekrusell/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
18
Abstract Views
346
PlumX Metrics