Explaining labor wedge trends: An equilibrium search approach

Abstract

(ProQuest: ... denotes formulae omitted.)1. IntroductionOver the last few decades, most OECD countries have shown large differences in aggregate hours of market work. The interesting issue of understanding these differences in work effort has resulted in a number of significant contributions. For instance, Prescott (2004) studies the taxes account for differences in labor supply over time and across countries from the early 1970's to the mid-1990's and finds that for acceptable values of labor supply elasticity, the effective marginal tax rate on labor income explains most of the differences at points of time and the large change in relative (to US) labor supply over time. On this line of research, Rogerson (2004) points to the role of taxes and technology as determining factors in the changes from 1956-2000, whereas Rogerson (2006) argues that changes in technology and government are promising candidates to explain the broad changes over the period 1956-2003. Finally, Ohanian, Raffo and Rogerson (2008) emphasize the intensive margin of aggregate hours of work and find that the neoclassical growth model, augmented with taxes, can account for most of the variations over the period 1956-2004.However, since the late 1970's, the differences in aggregate hours across countries seem to be largely to quantitatively important differences along the extensive margin. Moreover, the relative change in the employment rate behaves differently than the relative change in hours worked per employee. To stress this point, Langot and Quintero Rojas (2009) construct counterfactuals to quantify the relative importance of the extensive and intensive margins of aggregate hours of market work in the observed differences between Europeans and Americans since the 1970's. They show that the extensive margin explains most of the total-hoursgap between regions, while the intensive margin plays the smallest role. Furthermore, Ljungqvist and Sargent (2007a, 2007b and 2008) suggest that the large decrease in the employment rate in European countries observed after 1980, was an important factor in the dynamics of total hours worked. In addition, there is a bulk of evidence from previous literature on the European unemployment problem regarding the effects of labor market indicators other than taxes on the extensive margin4.This suggests that the basic neo-classical growth model with endogenous labor supply is insufficient to account for the impact of the various labor market institutions on aggregate hours of work. However, when this model is extended to include a search and matching process in the labor market it is able to explain the employment dynamics. An example of this is the study by Quintero Rojas (2009), who examines the incidence of various labor market institutions on the extensive margin to explain the evolution of aggregate hours over the period 1980-2003. However, her model holds the intensive margin constant, thereby neglecting an interesting dimension of the problem.Against this rich background, our main contribution is twofold. Firstly, we take into account the differentiated dynamics of the two main margins of aggregate hours of work, i.e., the average hours worked per employee (or intensive margin); and the employment rate (or extensive margin). This enables us to assess the relative effect of taxes on each margin, on the one hand; and that of unemployment benefits and workers' bargaining power on the other. Secondly, the analysis covers the updated period 1980-2013.More precisely, we develop a dynamic general equilibrium model with search and matching frictions, wage bargaining, and efficient bargain on the number of hours worked per employee. The model is extended to include a tax/benefit system consisting of taxes on consumption, labor income, and payroll, unemployment benefits, and the workers' wage bargaining power. Since the model distinguishes between the two margins of the aggregate hours of work, we are able to look at the relative contribution of taxes and labor market institutions to each margin. …