# **1. Introduction**

The rise in unemployment during an economic crisis poses a significant concern to policy makers. Moreover, layoffs could slow down the economic recovery, since re‐hiring and training workers may be costly for firms. This is particularly true for workers who have acquired job‐specific skills. For these workers, it may be beneficial for firms to not let them go in the first place. However, as firms face lower demand for their products, they may not have the financial means to keep paying these workers, particularly in the presence of credit constraints, which are often exacerbated during a crisis. There could thus be a case for government intervention through wage subsidies, which could limit layoffs and speed up economic recovery by eliminating search and training costs. In fact, 22 countries around the world used some form of wage subsidy program to promote employment retention during the recent economic crisis.<sup>1</sup> Much of the existing literature on wage subsidies focuses on subsidies for disadvantaged workers or for the unemployed (Kaldor 1936, Layard and Nickell 1980, and Phelps 1994), providing mixed evidence as to whether subsidies can improve the employment prospects of such workers (see Katz 1998 and Betcherman et al. 2004 for summaries of the literature). To my knowledge, there is, however, no empirical evidence on whether wage subsidies during an economic crisis can reduce layoffs and whether they promote economic recovery. This paper starts to fill this gap by examining a wage subsidy program that the Mexican government implemented in response to the recent economic crisis. Under this program, manufacturing firms in certain industries were eligible for receiving wage subsidies if they decided to keep their workers instead of letting them go during the period of January 2009 to August 2009.

I use monthly administrative data on employment at the industry level from the Mexican Social Security Institute (IMSS), covering nine years before and four years after program implementation, along with propensity score matching to construct groups of eligible and ineligible durable goods manufacturing industries that display statistically identical pre‐program trends in employment. I then estimate difference‐in‐difference equations and find a positive, but not statistically significant effect of the wage subsidies on employment during the program’s duration, ranging from 5.7 percent to 13.2 percent in magnitude, depending on the specification. The size of the effect is greater after the program ended: eligible industries had about 24 percent higher employment than ineligible industries, compared to the pre‐program difference in employment.

I then examine the time path of the program’s effect in more detail, estimating a separate effect for each year after the program (2009 to 2013) and find that the effect of the program increases over time – going from about 16 percent in 2010 to 31 percent in 2013. The findings thus suggest that employment after the program recovered faster in eligible industries than in ineligible industries. In fact, the data show that in eligible industries employment levels were back at pre‐crisis levels in 2011, while in ineligible industries employment levels were still not back at pre‐crisis levels in 2013. The impact estimates are robust to several alternative specifications and a falsification exercise.

> 1 Based on the ILO/World Bank Inventory of policy responses to the global financial and economic crisis of 2008 (http://www.ilo.org/empelm/projects/WCMS_158875/lang‐‐en/index.htm)

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