# **1. Introduction**

Despite a recent improvement in economic growth, unemployment in South Africa is still high. While the unemployment rate has declined from 29.4 percent in 2001 to 26.7 percent in 2005 (Statssa, 2006),<sup>1</sup> employment growth is, on average, only 2.1 percent per year (see, for example, Bhorat, 2005). That level of employment growth is slow relative to labor force growth and therefore insufficient to deal with the severity of the unemployment problem. Using a broader definition of unemployment to include discouraged workers, unemployment in South Africa is approximately 30 percent for men and 38 percent for women, and has almost doubled since the transition from Apartheid (Levinsohn, 2008). Reducing unemployment is therefore a major policy concern in South Africa and one policy option being debated is a wage subsidy scheme - see, for example, recommendations made by the Harvard Center for Interntional Ddevelopment (CID) South Africa Initiative and, in particular, the summary report of the International Panel on Growth in Hausmann (2008) as well as the policy options to alleviate unemployment in Levinsohn (2008).

The South African labor market presents an interesting economic issue - if there are wage and labor market rigidities in an economy, would a wage subsidy be able to reduce high structural unemployment? Using the particular institutional situation of South Africa, this paper investigates the circumstances by which a wage subsidy would generate significant employment effects. The methodology employed is a disaggregative economic framework – which combines a general equilibrium model commonly used in public finance to look at fiscal, welfare, and economy-wide effects of a policy change, and a micro-simulation model with occupational choice probabilities to examine the employment and distributional consequences at the micro level. In what follows, we briefly review the unemployment issues in South Africa and describe the approach adopted in the context of the paper’s objectives.

**_Why unemployment is high in South Africa._** There is an extensive literature about South Africa’s labor market issues, which are selectively summarized below. Three major and interrelated causes of unemployment are often cited – (i) insufficient economic growth, particularly in the tradable sectors; (ii) high real wages or labor cost; and (iii) labor market rigidities and other structural problems in the labor markets. In addition, other related factors cited include the participation pattern in the  labor force, the level of reservation wages, job search issues, and the impact of transfer payments. Bhorat and Leibbrant (1996), Bhorat and Oosthuizen (2005), and Banerjee, Galiani, Levinsohn, and Woolard (2007) provide a good overview.

A significant cause of unemployment in the past was the lack of economic growth during the 1970s, 1980s and 1990s (Fallon and Pereira da Silva (1994) and Lewis (2001)). Employment growth was therefore low (Standing, Sender, and Weeks (1996), Bhorat (2001)). Recently, however, unemployment has been high despite higher economic growth, suggesting that there are other underlying factors.

> 1 The rate is dependent on whether a “strict” or “expanded” definition is used.  The quoted numbers are for the former, which are more conservative or lower.  Even then, the unemployment rate is still high.

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