This dissertation decomposes labor supply into three margins step by step and studies the relative effects of two adverse labor market institutes on labor supply.
Average labor supply in the EU declined over 25% relative to that in the US over the past 30 years from the early 1970s to the early 2000s. Europe has also witnessed steadily higher labor income taxes and more generous government-supplied unemployment benefits, among others, than the US. Some studies attributed declining hours worked in Europe relative to the US to higher labor taxes, while other studies accredited high unemployment rates in Europe to more generous non-employment benefits. However, data indicates the difference of labor supply between the EU and the US comes from both the intensive (hours) and the extensive (employment) margins.
The first essay begins from studying a model that consider labor search within the neoclassical growth framework so as to investigate the effects on labor supply along both intensive and extensive margins in one unified general equilibrium framework. The theoretical results find that an increase in the labor tax decreases hours per worker and employment with an overstated adverse effect on hours worked if employment is fixed as is in Prescott (2002, 2004). Moreover, more generous non-employment benefits decrease employment and increase hours per worker, with an understated adverse effect on employment if hours per worker are fixed as are in Ljungqvist and Sargent (2007, 2008a). The numerical results show that increases in labor taxes and non-employment benefits together explain about 75% of declining labor supply in Europe relative to the US over the past 3 decades, with the fraction accounted for being increasing in the labor supply elasticity and decreasing in the labor’s contribution in matching.
Individually, labor supply declined more from employment in some countries and more from hours per worker in other countries. The second essay studies the relative detrimental effects of higher labor taxes on hours per worker and employment and finds that the relative effects depend on the mechanisms shaping the supply of hours per worker. When hours per worker are bargained by matched job-worker pairs, a higher labor income tax reduces both employment and hours per worker. As the laborer’s the hour bargaining power is larger, the negative effect is smaller on employment and larger on hours. When the supply of hours is decided exclusively by the household, together with the utility of leisure is linear in hours, the negative effect on employment is zero and all negative effects are on hours per worker. At the other extreme, when the worker’s supply of hours is effectively regulated by the authority, a higher labor tax only reduces employment with a zero effect on hours. Thus, these different hour-shaping mechanisms help understand the underlying mechanisms why, in facing higher labor tax rates in Europe over the past thirty years, some countries experienced more severe increases in unemployment rates while some other countries underwent sharper decreases in hours per worker.
The third essay takes the further step to consider the participation margin and compare the long-run effects of increases in labor taxes and unemployment benefits on labor supply in the models with and without the participation margin. With increases in labor taxes, thanks to discouraging labor forces, the employment is reduced less than that in the model without endogenous labor forces and, with ambiguous effects on hours per worker, labor supply is decreased by less. In the case of increases in unemployment benefits, due to inducing labor forces, employment increases instead of decreases in the model with exogenous labor forces and, with the effect on hours per worker being opposite to that on employment, the effect on labor supply is ambiguous in both models.
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The quantitative results reveal that the model without endogenous labor forces explains too much of the decreases in employment and labor supply in the EU relative to the US over the past 3 decades. In particular, it predicts an increase in hours per worker which is at odd with the data. By contrast, due to endogenous labor forces, our model explains a reasonable decrease in labor supply, along with a reasonable decrease in employment and a moderate decrease rather than an increase in hours per worker.
Relatively, the model with endogenous labor forces explains the difference in labor supply better than the model with exogenous labor forces.
Finally, we should mention that differences in labor-force participation may come from older and younger workers and female labor-force participation. Moreover, differences in labor supply may also reflect differences in workweeks, full and part-time jobs, holidays and vacation days. Our model and the models studied by Ljungqvist and Sargent (2007a, 2007b), Fang and Rogerson (2009) and Shimer (2011) consider neither life-cycle elements nor female and male labor-force participation, because these models are aimed at understanding differences in the labor supply or employment for a representative agent with full-time employment instead of the choice of part-time versus full-time and female versus male employment. Although there are some variations in the EU relative to the US, the key pattern these existing papers wish to emphasize is that the very large differences in average labor supply per person in the past decades are due to large differences in hours per worker and employment. Our model adds value to these existing studies in that by taking account of endogenous labor forces, it explains the difference in labor supply in the EU relative to the US better than the model with exogenous labor forces.
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