between capital and skilled labor, which adds to the rigidities in the factor markets. Furthermore, Aparteid left South Africa with a mismatch in the supply and demand of skills as a generation of workers did not receive the benefit of higher education. In this situation, equilibrium unemployment in the face of supply-side shocks and shifts would tend to be higher because the degree of coordination in wage-setting as well as real wage inflexibility would lead to less efficient supply-demand matching in South Africa (i.e. the Beveridge curve approach to unemployment). Moreover, factors such as hysteresis and persistence mechanisms, which were used to explain high unemployment in OECD countries, also point to the likelihood that a sustained period of high unemployment caused by weak aggregate demand can in turn cause a deterioration in the supply side of the economy, resulting in the long-term unemployed being detached from the labor force and a higher equilibrium unemployment rate.<sup>2</sup> The nonparticipation of the less-skilled who are jobless is a possible consequence of the structural problems in South Africa. A vestige of Apartheid is the geographical distance between where many of the unemployed reside and where firms are located. As a result, transportation cost is a deterrent to employment for less skilled labor; in effect, it creates a high threshold in their reservation wage. Various factors mitigate the necessity for immediate employment; these include income differences in the dual economic structure combined with within-household income transfers due to the availability of the old age pension or the employment of a family member in the formal sector also mitigate the necessity for immediate employment. See, for examples, Banerjee _et al._ (2007), Poswell (2002) and Dinkelman and Pirouz (2000), and Moll (1993).

**_Why a wage subsidy?_** Because of these structural issues in South Africa’s labor market, policy intervention such as a wage subsidy has become increasingly attractive.  Using a careful empirical analysis of individual-level changes and transitions in the labor market status observed from an extensive nationally representative panel of individual labor data, Banerjee _et al._ (2007) conclude that, because of the structural changes in the economy,  South Africa’s high level of unemployment is an “equilibrium” phenomenom; the decade-long high levels of unemployment appear to be a structural rather than a temporary aberration. Such structural unemployment cannot be solved by macroeconomic management or temporary swings in aggregage demand, but must be addressed by policy interventions affecting labor demand or supply such as wage subsidy, search subsidy, reduced regulations for first jobs and government employment. Banerjee _et al._ also note that there is much more churning in the South African  labor market than would be observed under the conventional view that the market is rigid.  However, much of the churning may reflect transitions or boundaries between searching  and non-searching that are more fluid between  being not economically active and informally employed than between any of those states entering into formal employment. Part of the reason noted by others is the small size of the informal sector, which does not provide a buffer between formal jobs and unemployment – Kingdon and Knight (2000) and Fallon and Lucas (1998). Another factor is the mismatch of skills noted above.

A basic justification for a wage subsidy is that it directly intervenes in the factor market to stimulate demand for less-skilled labor. Although a wage subsidy creates jobs in the short run,

> 2 See, for example, Nickell _et. al._ (2003). For a more general discussion, see Chapters 4 and 11 in Carlin and Soskice (2006).

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