# **1. Introduction**

Active labor market policies (ALMPs) have been used globally to help ease a wide range of labor market problems, including youth unemployment and persistent joblessness among displaced adults. Several active labor market policies are available to policymakers to boost employment. Among them, private employment subsidies have been used to cover part of the labor costs borne by employers, particularly for low-wage workers. In developing economies where unregistered – or informal – employment remains common, employment subsidies can also serve an additional purpose. In addition to increasing total employment, they can also help increase the proportion of workers who are employed formally – as opposed to being unregistered – by partially covering the labor costs of formal employment. By doing this employment subsidies reduce the relative attractiveness of hiring workers “off the books” for firms compared to formally employing workers. This is a potential benefit of importance, as reducing informality in the labor market is a common policy priority in many developing countries.

In this paper, we examine the effects of a geographically targeted subsidy that covered part of the employers’ social security cost on registered employment in Turkey. While small firms with fewer than 10 employees were not eligible for the subsidy before 2016, they became eligible in 2016. In addition, only small firms in certain regions of Turkey became eligible, which constitutes a quasi-experiment that we exploit. Our paper uses a very rich firm-level administrative dataset to study the effect of a social security cost subsidy on registered employment. We exploit geographical variation in eligibility for the subsidy and use several difference-in-difference specifications to estimate the causal effects of the subsidy on registered employment.

We find that the subsidy significantly increased registered employment in small firms and that the effects are sustained over time. The magnitude of the estimated employment effects is on the high end of the literature. The subsidy, which covered about 25% of social security costs and about 6% of total labor costs, increased registered employment in small firms that received the subsidy by 5% to 8% depending on the difference-in-difference specification used. Our results are quite robust to narrowing the geographical control group of firms used for the estimation. In addition, positive effects on registered employment appear fairly constant over the 3-year period during which the subsidy was implemented. Finally, we also provide corroborative evidence suggesting that the rise in registered employment in small firms attributable to the subsidy mostly resulted from the formalization of existing workers, rather than new job creation. Cost-benefit analysis suggests that the range of the effect size is not sufficient to equalize the cost of the subsidy to the government to the benefit received in terms of taxes and social security premiums. However, if a worker stays in the same firm after benefitting from the subsidy for four years, the net present value of the costs associated with covering the worker’s subsidy equalizes the net present value of premium and tax payments by the worker in less than a year after the end of the subsidy period.

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