Unemployment: Putting Europe back to work with
Back-To-Work Bonds
Unemployment is a
social problem with very high economic and social costs. It is the root cause
of many other social problems, and its solution should be a high priority for
the European Union. On fiscal grounds
alone, government has an interest in reducing unemployment. Unemployed workers
don’t pay income taxes, pay smaller amounts of indirect tax, and require
welfare benefits. Intervention can also be justified on the grounds that full
employment is in the nature of a public good: it lowers crime, vandalism, makes
people feel more secure, and adds to social cohesion.
Society is nearly
unanimous that unemployment needs to be lowered. Yet many have questioned the
role of government in helping to solve this, and other, social problems. This
skepticism about government intervention arises not from the aims of government
policy, but from the ways in which they are carried out. Most people believe
that government programmes have failed to solve the unemployment problem. And
it is true that government performance in this area - as in others - has been
lacklustre at best. A whole panoply of measures has been used in all the
European countries in attempts to get people back to work. By and large they
have failed. Unemployment rates have barely moved in the past few years, and
remain high.
The need for self-interest
There is no lack of
consensus on the need to reduce unemployment, nor is there lack of political
will. But actual results have been meagre. I believe that the reason for this
failure results from the very small role that the self-interest plays in
achieving lower unemployment. This essay will introduce a means by which
self-interest and market forces can be used to help achieve one of our most
important social goals: full employment.
Typical government
programmes targeting unemployment include:
• subsidising the cost of
recruitment to existing or new enterprises;
• supplementing the
income of prospective employees;
• matching vacancies with
those currently unemployed; and
• defraying costs of
training or transfer of new employees.
Other government
interventions have employment as an implicit objective. Aid programmes of this
type include: crisis aid; support for technical innovation; regional
development assistance; investment incentives; assistance for small and medium
sized enterprises; and export promotion. Another intervention that is largely
driven by employment concerns is the erection of barriers to imports - here the
costs to the rest of the economy are extremely high in relation to jobs saved.
There is nothing
intrinsically wrong with the intent of
these schemes, but I believe that their operation
is inefficient because they exclude the one vital ingredient - the ingredient
that has provided much of the impetus for the relative success of markets in
the private sector: self-interest.
How can we inject
self-interest into solution of the unemployment problem?
Back-To-Work Bonds
I propose that
governments, whether individually, or as part of a European Union initiative,
issue a special type of bond - Back-To-Work Bonds (BTWBs). These bonds would
differ from conventional bonds in that they would not bear interest; neither
would their date of redemption be specified. Government would undertake to
redeem these bonds only when a specified
low level of unemployment has been reached. They would be issued by
government by auction, and would thereafter be freely tradeable.
Consider an example.
Suppose that the governments of the
European Union decide to act together to reduce EU-wide unemployment. This
would be appropriate, given that the EU constitutes a single labour market.
Suppose further that they agree a reasonable objective is to lower the
unemployment rate to three per cent. (There are measurement issues here, which
we shall discuss these below.) My proposal is that the EU therefore issues
bonds that will become worth, say, EUR10, only
when unemployment falls to this target level. Because this objective is seen
as fairly remote by bond purchasers, the BTWBs might sell, initially, for only
€2.50 each. People who buy the bonds may not think that they can do much
themselves to relieve unemployment. If most of the bonds were purchased by such
people, the value of these bonds would fall further. Remember that there would
be a market for these bonds, and that their prices would be quoted frequently.
Their market value will rise and fall as events appear to make the target less
or more remote.
Bondholders would
therefore experience a fall in their value of their assets. Crucially though,
at some point, the bond value would become so low that their would be a
powerful incentive for others to buy the bonds and then do something to reduce unemployment. They own an asset that would
quadruple - or more - in value, once unemployment is down to three per
cent. The government has nothing more
to do until that objective has been achieved: the holders of the bonds now have
a strong interest in seeing the value of their bonds increase as quickly as
possible. If other people's interest is stronger they will bid more for the
bonds than the current holders think they are worth, and will thus own them. So
the bonds will generally be in the hands of those with the strongest interest in
seeing the objective attained.
Who would buy the bonds?
There would be two
main categories of bond purchaser: active and passive. Active holders would be
motivated to do something to reduce unemployment; passive holders are would-be
free riders, who would hold the bonds with the aim of making an effort-free
capital gain.
1 Active holders
The most important
category of active holders would be investors or brokers who would use their
own capital, or borrow on the strength of the redemption value of the bonds, to
initiate or facilitate projects aimed at reducing unemployment. Other active
holders would be large employers, whose bond‑holding would, in effect,
subsidise, their recruitment of unemployed workers.
Active holders could
be expected to increase employment by using part of the present value of their
expected above‑normal yield from early redemption of the bonds to finance
their own, or others', labour recruitment drives. Note that active investors in
the bonds could co‑operate or collude with each other, to help achieve
the targeted objective.
2 Passive holders
These include:
• casual purchasers, who
might buy bonds in the same way as they would a lottery ticket;
• speculators, who
believe that the likelihood of the targeted objective being achieved is greater
than the rest of the market thinks it is; and
• hedgers, who stand to
lose if the particular objective is actually achieved. They might buy bonds as
a form of insurance policy against this possibility.
All these passive
investors would want to become 'free‑riders', hoping to benefit from any
increase in the bond price without actually participating in any objective‑achieving
projects. But (see below) the way markets work would limit the opportunities
for these would‑be free riders. The more bonds these passive investors
own, the more remote the targeted objective becomes, and the more they would
stand to lose as the value of their bonds falls. So passive investors may find
that, collectively, their holdings were so significant that they would be
better off selling them, even at a loss.
Self-interest again
Prospective holders
of Back-To-Work Bonds have an incentive ‑ and given free capital markets,
the means ‑ to buy them from current holders, active or passive, if they
think they can do a better job of achieving the targeted objective.
Many of the
initiatives that would be stimulated by the BTWBs are taken by governments
nowadays, but the critical difference is that, under a bond regime, the
initiatives are stimulated by the self‑interest of the bondholders and
are not operated by a bureaucracy that, however well‑intentioned, is not
rewarded in ways that correlate to its success in achieving objectives.
Back-To-Work Bonds provide a strong motivation for bondholders to seek out those
ways of reducing unemployment that will give them the best return for their
outlay.
The bonds direct self‑interest
into those processes necessary for objective achievement that will respond most
readily. The government does not have to plan this: it is the self‑interest
of bondholders that ensures it.
Current efforts by
government generally focus on only the most obvious causes of unemployment, or
on the most obvious remedies. So inefficient industries on the verge of
bankruptcy might receive vast amounts of taxpayers’ money at the expense of
cheaper job‑creation initiatives. But perhaps the worst example of a
government response to unemployment in manufacturing is protection from
imports. Such barriers to trade cost consumers sums out of all proportion to
the benefits received by the protected workers. If these sums were instead
allocated to cheaper job creation or preservation initiatives, countless more
jobs would be saved or created.
Government response
to the unemployment problem is then typical of its initiatives in other areas.
They are well-intentioned, certainly, but they are also cumbersome, and
unresponsive to local conditions or events. They often conflict with other
programmes. As a result, they are inefficient. The problem is systemic: self-interest
doesn’t operate, so there is little reason for government agents to work
efficiently. Rewards to government employees are not correlated with their
success or otherwise in achieving lower unemployment. If anything, the
incentives are perverse: a job creation body that was overly successful would
probably be dissolved, and its own employees would have to look for something
else to do. Such a system defeats enterprise and stifles a creative solution to
the unemployment problem. The total effect is to reduce efficiency.
Back-To-Work Bonds
improve on the vague, conflicting or inadequate existing programmes, that are
not only inefficient, but can also expose decision‑makers to bribery or
corruption. They have another significant advantage over conventional policy,
in that government pays only when the targeted objective has been achieved.
The market for Back-To-Work Bonds
For the BTWBs to work
it is essential that active investors purchase the bonds and do something to
reduce unemployment. But there is no need artificially to boost investor
interest in the bonds: the anticipated supernormal profit arising from early
redemption of the bonds generates the required self‑interest and so
supplies the motivation for reducing unemployment, provided there is a buoyant market for the bonds.
BTWBs, once issued
and sold, must be readily tradeable at any time until redemption: a healthy
secondary market is critical to the operation of the BTWB mechanism. Many bond
purchasers will want, or need, to sell their bonds before redemption ‑
which may be a long time in the future. If there were no secondary market,
these holders would not be able to realise any capital appreciation experienced
by the bonds. This would remove much of the incentive to purchase the bonds in
the first place.
But there is another
important reason for requiring a healthy secondary market in the bonds: active
investors may be able to speed up only one, or a few, of the processes
necessary for the targeted reduction in unemployment to be achieved. Once these
investors have done their bit, and seen the capital value of their bonds in
line with the increased probability of the bonds' early redemption, they may
have no wish to speculate on the speed at which the remaining processes will be
carried out. Other groups of active investors, who will have greater expertise
in performing these later processes, must be given an incentive to use their
expertise to accelerate attainment of the targeted objective. The possible
capital appreciation of bonds bought from previous owners and sold at a still
higher price [or redeemed] provides this incentive. The new owners will, if
they are successful in these later stages, realise this capital
appreciation.
Bonds therefore would
tend to flow outwards from those who had helped as much as they can to achieve
the targeted objective, as well as from free riders. In fact, though, it is not
necessary for there to be any actual flow of bonds. What would flow could be
bonds, but it could also be finance from bondholders. The important point is
that the bond mechanism ensures that the people who allocate the finance have
just as much incentive to allocate efficiently as those who receive it have to
reduce unemployment efficiently. At the limit we can conceive of just one
single buyer of all the bonds. If this buyer were determined to hold on to the
bonds until redemption, then the bonds would function as a sort of performance‑related
contract, with the government paying only when the objective has been achieved.
The buyer could contract out most, or all, of the work required to achieve the
objective, with the incentives given by the bonds for speedy accomplishment
cascading down from the bondholder to those subcontracted to help reduce
unemployment to the target level.
The secondary market
is also necessary from the government's point of view. Government could, as a
competitive supplier of objective‑achieving services, participate as an
active investor in BTWBs. Note that, unlike in industry, even if the operations
of government were successful only because they were subsidised, the private
sector would be unlikely to cry 'unfair competition'. This is because its bonds
would also appreciate as a result of government [or government‑inspired]
activity. It may be necessary, for some objectives, for government to give some
assurances about it future behaviour, if it is thought that without such
assurances there would be too much uncertainty for markets in the relevant
bonds to operate.
Government, while it
may profit from appreciation of the bonds it purchases, will also be interested
in the cost of its social policies. The BTWB principle is superior to existing
budgetary mechanisms in that the cost of each scheme is not only inexorably
linked to attainment of its objective, but its maximum cost can be decided in
advance. The number of bonds is limited, and the most the scheme could cost the
government would be the cost of redeeming the bonds very soon after they are
issued [this assumes a negligible issue price] plus all the administrative
costs. Even then, though, the objective would have been achieved before any
cost is incurred.
The efficiency of
BTWBs could be tested by allocating the same sums of money as are currently
allocated for a particular social objective to the redemption of BTWBs
targeting the same objective. The maximum cost to the government of the issue
could then be set so as not to exceed the expenditure that would anyway have
been incurred in pursuit of the same
objective.
We should note too
that BTWBs allow for the complexity of the unemployment problem. No single
approach will solve that problem, so a wide variety of approaches to its
solution is essential. BTWBs will encourage and reward the most efficient of
these approaches. This occurs because of the nature of the bond mechanism, and
requires no selection or supervision by government [or government agency] of
the most efficient policy. Only the objective, not the policy, is dictated by
government. This feature tends to stabilise the political environment, given
the is near‑unanimity over the need to solve the problem. It is worth
noting that a new government is unlikely to default on BTWBs, even if the bonds
had originally been issued by ruling parties with a different political
outlook. The risk that it might, and so become the first government openly to
support higher unemployment, would not be much greater than that of a
government refusing to redeem fixed interest stock issued by any of its
predecessors. This risk, always present, in now way impedes the operation of
bond markets.
Measurement and sustainability
To be effective, the
measure of unemployment targeted by BTWBs must be carefully defined. For
instance, it would be unsatisfactory to redeem the bonds immediately
unemployment fell to its targeted level. The real objective is a sustained level of low unemployment, and
this would have to be achieved before the bonds could be redeemed. Also, the
definition of unemployment would have to be standardised - perhaps using OECD
methodology. Governments would have to think carefully about what they want to achieve: a reduction in
unemployment defined as those who receive unemployment benefit; a reduction in
total welfare benefits to the unemployed; or an increase in the numbers of
full-time equivalents in employment? All these, and other alternatives, or
combinations of alternatives, would have to be considered as targets for BTWBs.
When an agreed
objective had been achieved, and as the bonds are redeemed, another set of
bonds, aiming at sustaining or reducing still further, the unemployment level
could be issued. Importantly, the cost to the government of each additional job
created is likely to be lower than previously. This is because the first BTWB
issue would lead to the development of new job creation mechanisms and pathways
that would not have to be recreated to sustain or further reduce the
unemployment level targeted in the first issue.
Advantages
• The main advantage of
BTWBs is that they make the achievement of low levels of unemployment more
efficient than the current array of policies by injecting self‑interest
into every stage of the necessary process. For the same government expenditure,
therefore, more can be achieved. Additional gains accrue for other reasons.
• The bonds guarantee
stability of policy objectives. Policy instability is an important reason why
people do not undertake unemployment reduction projects. Many programmes have a
limited life and there may be expectations that they will be replaced by other
programmes. But unemployment reduction has a long lead time. While the most
efficient way of reducing unemployment might change, the objective targeted by
BTWBs will remain constant. Holders of the bonds would not be deterred from
taking measures to reduce unemployment by fears of a reversal of government
policy ‑ or indeed, a change of government. In the current policy making
environment, decisions about projects are plagued by policy uncertainty arising
from government decisions that are subject to all the whims and inefficiencies
of political expediency. Uncertainty also surrounds the behaviour of the
aspiring political parties, which differ not so much in their stated
objectives, but more critically in the ways they will strive to achieve them.
• The bonds make the
objectives of unemployment policy more transparent. Apologists for current
programmes can often point to easily identified beneficiaries, but the net
effect of many policies, even those supposedly aimed at reducing unemployment,
is in fact to raise unemployment: this is often stated to be a result of high
trade barriers. BTWBs targeting national or EU levels of unemployment would
ensure that indirect methods of achieving them would be encouraged only if they
were efficient from the point of view of the whole economy.
Also,
for the BTWB mechanism to work, explicit targeting of the unemployment
objective requires explicit calculation of the value of its achievement ‑
a useful discipline, but one rarely followed by today's politicians.
Potential problems
There are three
sources of potential problems with the BTWB scheme.
1 The free rider problem
People may believe
that the value of bonds will increase without their doing anything to reduce
unemployment. Thus, a large number of the bonds would be held by free riders.
But the BTWB mechanism acts against the interest of these would be free riders.
If they own a large proportion of the bonds, the value of the bonds would fall.
Eventually it would fall so low that it would be in the interests of an active investor
to buy their bonds. It’s likely that any free riders would be small players:
they would be disadvantaged relative to larger, active, holders as they would
know not have the access to information that larger, active holders have. So
they would know less about the true market value of the bonds. In such ways,
would be free riders would be discouraged from buying even small holdings of
BTWBs.
2 Distribution of gains
This potential
problems arises because bondholders would receive only a proportion of the
benefits if the objective is achieved. People might not take action to reduce
unemployment because, they believe, even if they do something to reduce
unemployment, their rewards would depend on others doing the same, and they may
not receive rewards proportional to their success.
However, I believe
this potential problem will not arise. Because a large number of small bond
holdings would do little to solve the unemployment problem, the value of the
bonds would fall until there was aggregation of holdings by people, or
institutions, large enough to initiate unemployment-reducing projects. But even
these bodies may not be big enough, on their own, to achieve much, without the
cooperation of other bondholders. So there would be a powerful incentive for
bond holders to cooperate with other bond
holders to help reduce unemployment. Aggregation of holdings, and
cooperation of holders, would stimulate effective unemployment reduction
initiatives.
Another possible
problem arising from the integration of BTWBs into the current policymaking
system arises from government's (either EU or national) role as creator of
statutes. Laws affecting the bond price could be passed. For instance,
government could come under great pressure not to increase unemployment
benefits from holders of bonds targeting unemployment. Note though, that the
source of the pressure, and the motivation for it, would be easy to identify.
In any case, the threat of such pressure has a positive aspect: for bond issues
to be as successful as possible, governments would have to give assurances as
to their future behaviour. If they failed to give such assurances, the value of
the BTWBs would factor in such uncertainty, and their market value would be lower
than otherwise. This could be another means by which BTWBs stabilise political
objectives.
These problems should
not be overstated. Existing laws, careful choice and specification of targeted
objectives, and tighter rules on investments and declarations of interest by
European or national lawmakers would probably circumvent them. And the question
of how well BTWBs would achieve societal goals needs to be considered alongside
current policymaking methods. In today's environment policymakers can escape or
deflect censure because the adverse results of their policies are difficult to
relate to their cause. If BTWBs were to lead to negative effects, the
relationship between these effects and their cause would be identifiable, and
the filtering out of negative effects would be a simple matter compared to the
methods available to today's policymakers.
Markets and government
The principle
underlying BTWBs can be used to solve other social problems. In Britain, there
has been much talk about the Third Way; between unrestrained capitalism, and
socialism. The mechanism behind BTWBs uses market forces to achieve an
objective that used to be thought of as socialist. Simplistically, it uses
right wing methods to achieve left wing goals, though these terms hardly apply
any more in Europe, where politics has moved on to embrace such concepts of the
inclusive society, or the stakeholder economy.
Resources are always
going to be limited and Back-To-Work Bonds will not change that. Priorities and
choices will always have to be made: under the BTWB principle, governments will
still decide on the targeted reduction of unemployment, and the sums allocated
to that reduction.
Democratic
governments are good at representing and articulating their people's wishes,
but they are not so successful at working out the most efficient ways of
achieving these goals. This achievement is really a matter of allocating scarce
resources: in economic theory, and on all the evidence, markets are the best
way of allocating scarce resources to achieve prescribed ends. Back-To-Work
Bonds are a reflection of governments doing to do what they are best at ‑
prescribing ends ‑ and markets to do what they are best at ‑
allocating resources to meet these ends. In so doing, BTWBs can achieve
society's distributional objectives more efficiently and less randomly than the
current array of regional and national policies.
In the long run the
widespread acceptance of the fact that self‑interest can be channelled
into benefiting the unemployed could have more far‑reaching implications.
Other social problems, such as crime, poor health, illiteracy or pollution
could be made the targets of future bond issues.
However, the
surrendering of policy instruments to the private sector, even with the aim of
achieving a goal as uncontroversial as full employment, may be politically
difficult, and must be a gradual process. But the potential benefits should not
be ignored. Getting people back to work should be a high priority, and I
believe that Back-To-Work Bonds, by injecting self-interest into the solution
of the unemployment problem, would be the most effective way of achieving full
employment. This would benefit the disappointingly large numbers of people who are currently unemployed, as well as
society in general.
© Ronnie Horesh
October 1998