Efficient Wage Subsidies in Private Firms and Deadweight Spending

Abstract

This paper links the old literature on employment subsidies with the current theories of contract and regulation. One important source of inefficiency of employment subsidies is deadweight spending. This refers to the cases in which private firms receive a subsidy for employment creation that would have been reached without this financial support. We identify the asymmetry of information between the regulator and the private firm as the source of this deadweight spending. The private firm knows its hiring capability while the government does not. We then derive the optimal incentive contracts for the government. In these contracts deadweight spending is reduced to the information rent to private firms. We derive conditions for which this deadweight spending is zero.Contract-Theory; Principal-Agent; Economic-Policy; Employment-Subsidy; Cost-Benefit-Analysis