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Is this jobless strategy too good to be true?

Economists are notorious for warning there is no such thing as a free lunch. But this week, Professor Richard Layard, director of the LSE's Centre for Economic Performance, served up a costed plan that would cut long-term unemployment by 400,000 over the term of a parliament, with an eventual annual saving to the Treasury of over pounds 200m. Is it too good to be true?

The plan is a hard-headed view of the effect of benefits on unemployment. In last year's Jobs Study, the OECD drew attention to the link between generous entitlements and high unemployment. Professor Layard highlights the link between length of entitlements and duration of unemployment.

In particular, he points to the marked divergence between long-term jobless rates in Europe and the US. The US does not have a high incidence of long- term unemployment because benefit is cut off within a year. By contrast about half the jobless in Europe - where benefits are available for much longer - have been out of work for a year or more. Despite the moves towards a more flexible labour market in the UK, over a third of the current 2.3m claimants have been without a job for a year or longer.

The benefits safety net turns into a trap because the longer someone is out of work, the less likely he or she is to be able to get a job. Demoralisation sets in and employers are reluctant to take on anyone who has been unemployed for long.

The solution is a mix of carrot and stick that strikes a balance between the harsh American and pampered European approaches. The Government would guarantee a job for six months to anyone who has been on benefit for 12 months. In return that person would have to accept a reasonable offer of work. The benefits currently made to the long-term unemployed - pounds 65 a week including housing subsidy - would be paid to employers as an incentive to hire them.

The effect of the scheme, suggests Professor Layard, would be to raise the employability of those currently languishing as long-term unemployed. When the temporary job ended, he or she should stand a better chance of continuing in that job or being re-employed elsewhere. The resulting decline in long-term unemployment would, in turn, bring savings to the Exchequer. And this decline would not worsen the trade-off between unemployment and inflation because the long-term jobless exert very little downward pressure on inflation.

The first objection to the plan is that it would create a favoured category that would displace others already in work. The subsidy would lead employers to substitute the formerly long-term unemployed for those already in work.

Professor Layard argues that this concern amounts to the "lump of labour" fallacy, the idea that there is a fixed amount of work that has to be shared out. The effect of his plan would be to expand the employable labour force; employment would increase in tandem.

However, in this year's Employment Report, the OECD said: "It is widely agreed that hiring subsidies for private-sector jobs will generate substantial displacement and substitution effects on employment." If this is the case, then the idea that the plan could be achieved cost-free seems fanciful; the Treasury would foot the bill for employers taking on the new subsidised employees. Additional costs would also arise if in-work benefits had to be paid to employees - particularly in no-earner households - to make the job offers spring the poverty trap.

Another question-mark concerns the causes of long-term unemployment. It is not clear that employers discriminate against the long-term jobless simply because of their lack of recent work experience. According to the OECD, unskilled workers who lose their jobs are much more likely to drift into the ranks of the long-term unemployed. Again, further costs seem inevitable in combining the job offers with retraining if the present group of long-term unemployed is not simply to shuffle between temporary jobs every 18 months.

There must also be a doubt about who, in practice, would make the job offers. If private-sector employers did not make a sufficient number of offers - maybe because of lack of skills on the part long-term jobless - the public sector would have to become the employer of last resort. The scheme would come to be seen as providing make-work as well as running counter to attempts to promote efficiency in government.

Yet despite these shortcomings, the general approach set out by Professor Layard is surely to be welcomed. It must make sense to subsidise work rather than inactivity. We cannot afford - socially more than economically - to exclude almost a million people from the labour market. The employment gains may be less than he suggests and the financial costs greater, but the social benefits argue in favour of boldness rather than timidity.

Preventing Long-term Unemployment; Employment Policy Institute; 840.