Work and Leisure in the US and Europe: Why so Different?

Alesina, Glaeser and Sacerdote, Working paper

Why Do Americans Work So Much More Than Europeans?

Prescott, Working paper

Google scholar cites: 358

Summary

• Americans now work substantially more than Europeans; wasn’t true 40 years ago

• Prescott studies a simple representative agent model

• Finds that taxes can explain all the differences in labor supply

• I will augment Prescott’s work with other info, especially from Alesina, Glaeser and Sacerdote (henceforth AGS, 2005)– Also, some cameos by Dew-Becker and Gordon, 2007

US vs EU E/N

0.30

0.35

0.40

0.45

0.50

0.55

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Em

plo

ymen

t-P

op

ula

tio

n R

atio

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1.25

EU

-US

rat

io

US

EU-15

Ratio(Right hand axis)

Raw Data for Hours Per Employee

1500

1600

1700

1800

1900

2000

2100

2200

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

US

EU-15

The basic facts

• European labor supply fell throughout the postwar period– Both intensive and extensive margins

• EU labor productivity caught up to the US

• Output per capita never gained

• Prescott’s question: what explains the changes in employment?

The theory

• Standard RBC framework,

– Where c is consumption, h is hours

• Highly stylized, but a reasonable starting point– Unit IES, no wealth effects on labor supply

• α is key in determining labor supply

0

100loglogmaxt

ttt hcE

Budget Constraint:

– tc, tax on consumption

– tx, investment tax; x investment; δ depreciation

– th, marginal tax on labor

– tk, capital income tax

– Tt, transfers; Gov’t gives all the tax revenue back

• The key is the price of consumption relative to leisure; depends on tc and th

ttttktth

txtc

Tkkrhw

xc

11

11

Key equilibrium conditions

• Labor supply:

• Wage:

• Elasticity of hours wrt wages:– Prescott calibrates α to match the average

level of employment– Elasticity is 0.77– This is roughly the same number one gets by

regressing employment on taxes

wc

h

1

/1

1/

hkw /1

wht

z

11

Labor Taxes in Europe

25

27

29

31

33

35

37

39

41

1980 1985 1990 1995 2000

10

15

20

25

30

35

40

45

Anglo-Saxon

(right hand axis)

Continental

Nordic

Mediterranean

Taxes on second earners

• Labor supply increase in the US between ’70 and ’93 is entirely driven by married women– Single women are a small part of the working

age population…

• 1986 tax reform reduced taxes on second earners (see next slide)

• A similar reform in Spain raised labor supply by 12 percent

AGS on labor supply elasticity

• Note that α governs both the level of employment and the elasticity wrt taxes– The elasticity is zero if you have no unearned income

• Prescott’s η=0.77• Labor literature says

– ηmen ≈ 0 (upper bound 0.35)– ηwomen ≈ 1

• AGS argue taxes explain at most half the gap between US and Europe

wht

z

11

0

0.2

0.4

0.6

0.8

1

1.2

15 to 19 20 to 24 25 to 34 35 to 44 45 to 54 55 to 64 65+

EU-15Tortoises

Middle Countries

E/N Ratio to the US

50

55

60

65

70

75

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Fixed Policy

Predicted

No Post-1995 Dummy

Male Employment

Effect of the post-95 dummy (6.32%)

Effect of the Policy variables (1.47%)

35

37

39

41

43

45

47

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Fixed Policy

Predicted

No Post-1995 Dummy

Female Employment

Effect of the post-95 dummy (2.38%)

Effect of the Policy variables (1.75%)

AGS’s Alternative Hypothesis

• One way to read the results is that there is a big macro elasticity but a small micro elasticity

• Maybe there are complementarities that magnify micro effects

• AGS argue for complemetarity in leisure– We all coordinate on the weekend– Women happier staying home if they have friends– We want vacation at the same time

• Then unions and gov’t may have a place in solving coordination problems

• Prescott may be right for the wrong reasons

The Social Multiplier• A social multiplier assumes that the value

of leisure depends on the leisure taken by others

• Social multiplier means V12>0

• Let

• Then the social multiplier is 2v1/(2v1-v2)

• v1>v2 implies social multiplier < 2

• Too small for micro elasticities to account for macro regressions

)ˆ1,1())1)(1(( llVwtlUU

)ˆ1)(1()1()1()ˆ1,1( 22

10 llvlvlvllV

Some suggestive evidence

• People take weekends off together

• People tend to work 9–5 instead of staggering shifts

• Holidays are grouped together

• Social multiplier might come from increasing returns in work (e.g. Ciccione and Hall)

• However, AGS settle on 0.2 as a reasonable micro estimate of LS elasticity

• A maximum social multiplier of 2 implies a macro elasticity of 0.4– The 0.2 estimate probably includes multiplier effects

already anyway

• Prescott overstates the case – taxes explain at best half the LS difference– And for him to be right, unions and hours limits must

be optimal!

What are the alternative explanations?

• Many policy differences between EU and US– Implicit taxes on earnings after retirement age– Unemployment benefits– Tax rates on second earners– Employment protection legislation– Product market regulation

• If Prescott is right, they don’t matter

Employment Protection Legislation

0

0.5

1

1.5

2

2.5

3

3.5

4

1980 1985 1990 1995 2000

Anglo-Saxon

Continental

Nordic

Mediterranean

A policy proposal

• Suppose we take Prescott’s parameters as given– I.e. the macro elasticity is causal, maybe due to a

social multiplier

• Now we can go from a pay-as-you-go to fully funded social security– Not possible with fixed labor supply

• Proposal: allow people to lower their tax rate by 8.7% and put it in a retirement account– Intuition: leads people to work substantially more– This only works by stopping redistribution

• Sets up a big OG model:– Wages grow at 2% per year– People work from age 22 to 63– SS benefits equal 32% of wages at retirement– Prevailing marginal tax is 40%

• Then simulates the effect of the proposed policy change

The effects of employment on productivity

• Historically, productivity tends to grow quickly when labor is scarce– Habakkuk hypothesis– Clark paper on cotton mills– US postwar experience

• Does this explain the recent experience of Europe?– Employment rises post-1995, but productivity

slows

Productivity Regressions• Instrument for

employment changes with labor taxes

• Coefficient on employment is twice what we would expect

• EPL and ARR have independent positive effects on productivity

Employment Rate -0.64***(0.20)

Output Gap 0.68***(0.11)

Product Market 0.56Regulation (0.45)

Union Density 0.03(0.12)

Employment 1.66***Protection Legislation (0.65)

Unemployment 0.14***Benefits (ARR) (0.05)

High Corpratism Dummy -0.49(0.94)

Post-1995 Dummy -0.14(0.24)

R2 0.63RMSE 0.95N 320

Conclusions

• Prescott is provocative• Nice implementation of a canonical theory• AGS show that his results are probably too

strong– Taxes explain at most half the variation in LS– Why rule out all the other things Europe does

wrong?

• The strong macro elasticities imply policies limiting employment may be efficient

Labor’s share of income

0.580

0.600

0.620

0.640

0.660

0.680

0.700

0.720

0.740

0.760

1980 1985 1990 1995 2000

EU-15

US

Labor’s share of income

0.580

0.600

0.620

0.640

0.660

0.680

0.700

0.720

0.740

0.760

1980 1985 1990 1995 2000

France

Germany

UK