Unemployment: Putting Europe back to work with Back-To-Work Bonds - Social Policy Bonds

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Unemployment: Putting Europe back to work with Back-To-Work Bonds


This essay is about 4150 words length

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 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 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 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 hoping to benefit from any increase in the bond price without actually participating in any objective projects. But (see below) the way markets work would limit the opportunities for these would 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 of the bondholders and are not operated by a bureaucracy that, however well 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 into those processes necessary for objective achievement that will respond most readily. The government does not have to plan this: it is the self 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 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 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 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

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 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 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 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 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.


  • 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 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.

3 Government’s role as creator of statutes

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 can be channelled into benefiting the unemployed could have more far 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, 1998

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