Americans spend almost 50 percent more time in paid employment than do Western Europeans. This gap in work time emerged in the 1970s and has grown to dramatic levels in recent decades. What factors cause this large discrepancy in lifestyles? To what extent can this be explained by differences in taxes and government spending, unionization rates, the stringency of employment protection laws, and other labor market regulations?
Please join us as AEI visiting scholar Steven J. Davis and Professor Alberto Alesina of Harvard University discuss and debate these issues. AEI resident scholar Kevin A. Hassett will moderate the discussion.
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Steven J. Davis, AEI and the University of Chicago
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Alberto Alesina, Harvard University
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Kevin A. Hassett, AEI
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The American Way of Work
Americans spend almost 50 percent more time in paid employment than do Western Europeans. This gap in work time emerged in the 1970s and has grown to dramatic levels in recent decades. What factors cause this large discrepancy in lifestyles? To what extent can this be explained by differences in taxes and government spending, unionization rates, the stringency of employment protection laws, and other labor market regulations? These and other questions were considered at a September 22 AEI panel discussion.
Kevin A. Hassett
Today we will hear two takes on why it is that Americans seem to spend more time (up to 50 percent more) in paid employment than Europeans, even though it used to be the exact opposite.
Steven J. Davis
The latest numbers from the Organisation for Economic Co-operation and Development (OECD) on average hours worked by person of working age shows a big difference between Europe and the United States that needs to be explained.
I will focus on the extremes in terms of numbers of hours worked–that is to say, countries with the longest and shortest working hours. I will focus on the most important explanation and driving force--the rate of taxes and the size of government.
France, Germany, and Italy have experienced noticeable declines in average working hours since the 1950s. Australia, Canada, and New Zealand have shown no such decline, and in the case of the United States, the average number of hours spent in paid employment has risen. Since trends have diverged over time, we must look elsewhere than culture to find an explanation. Cross-country comparisons point to a large role for taxes effecting decisions on labor income.
By 1995, there had been large differences in tax rates that were in place over time. There is a strong negative correlation between hours worked and (labor + payroll + consumption) tax rates. An increase in the tax of 10 percent corresponds to a reduction in work of about ninety-five hours. So, the relationship is strong--whether it is causal is another matter.
The big decline in hours worked has coincided with a big increase in the tax burden. The countries with a large share of government to GDP tend to have a large decline in hours worked (this is the subject of an important paper by Ed Prescott).
There has not been much reversal in the size of government, other than in the Netherlands and Ireland, where the tax to GDP rate has fallen. In the Netherlands, there was a reversal in time worked that tracks the rise and fall of the tax burden. The patterns for Ireland are also unusual for rich countries hours worked.
There is a huge volume of economics literature on how tax effects labor supply and work activity. I have some problems with much of the traditional empirical literature, which is misleading and focuses too much on the short-run responses to taxes–and therefore misses much. In my opinion the response to taxes is larger over the long run. It takes some time for capital and labor to move across industries or regions, and similarly it takes time for it to move from the official to household or informal sectors of the economy. The best estimate suggests that this sector of the economy is around a quarter to a half of GDP, so it is very significant. The underground sector is best estimated at 15 to 20 percent of official GDP. So these alternative production sectors are big.
Taxes effect lifestyle choices--for instance, whether it makes sense for married couples to both work. It effects whether you take disability benefits or carry on working. It effects whether you retire at fifty-five or sixty-five. These are not short-run decisions, but accumulate as a response to tax incentives over time.
The underground economy is a network of like-minded people which takes time to develop and evolve--but also to unravel when regulations change. Social norms are also influenced gradually over time by financial incentives, such as tax rates. Initially, people may not be willing to evade taxes, but may if they see their neighbors doing so.
The incidence on behavior does not fall equally--prime age men work similarly, but younger and older men work differently in Germany to the United States. Employment rates for older workers are very much the result of tax and pension incentives. As for the young, you may also see a large burden that results from minimum wage legislation.
Two-thirds of men aged fifty-five to sixty-five in Belgium have already exited the labor force. In the United States it is only one third. We can ask the questions: how do countries differ in the implicit tax of working one more year and how does it effect the expected present value of your retirement benefits by delaying retirement for one more year. In the United States, work is well rewarded, but in other countries, working actually reduces your total retirement income. There is a strong correlation between the marginal tax burden of working an extra year, and the unused productive capacity in the economy.
Countries with high tax rates also show lower rates of employment in the service sector (eating, drinking, lodging), where work is easily substitutable between the market and non-market activity. For instance, you can eat at a restaurant, or cook and wash-up yourself. Tax has the effect of shifting activity away from the market sector and away from a division of labor. Low-tax countries show about 25 percent of employment in these sectors that are easy to substitute. High tax countries show about 10 percent in these sectors. Taxes do not just reduce market activity, but also shift the composition of it.
A common element of easily substituted activities is that they tend to be supplied by less skilled and secondary income earners. As taxes shift the composition of economic activity, they are being shifted onto the most tax-sensitive areas of the workforce with the highest labor-supply elasticity.
It is not just the size of social insurance programs that matter, but the details of the design. For example, Sweden has very large subsidies covering 90 percent of the cost of pre-school child care, which is contingent on employment. So, if you tie social benefits to employment, you get higher employment than if otherwise. It also serves to encourage demand for the labor of young women who provide the child care, which will increase employment, given the numbers that are close to the margin between work and non-work.
I am not going to say that the size of government is unimportant, but our disagreement centers over whether tax is the only cause of differences between the length of times that Americans and Europeans spend in paid employment. I believe that it cannot be the whole story, or even the most important story.
With a dramatic decline in working hours since the 1960s, we need to explain why Europeans used to work more and now work less. There are two existing arguments. Firstly, Ed Prescott’s tax argument for a substitution effect, which assumes that all the difference is due to taxes, and he then calculates the elasticity of labor required for this to be true, which is extremely high. Secondly, there is Blanchard’s view of Europe assuming an income effect choosing to consume more leisure as they earn more. There is no evidence that labor elasticity is as large as Prescott suggests, and so you need to, like Steven Davis, consider the effects of governments in other ways to explain the difference.
You dismiss the cultural argument since Europeans might simply have a higher utility of income. Economists are generally not satisfied with using differences in utility functions as explanations, but this cannot be dismissed. Our explanation is the effect of union membership in Europe being greater than in the United States and having changed over time.
The difference in work hours per person can be explained by three things: the difference in the percentage of population that are employed, the difference in vacation time taken, and the difference in the length of the working week. The fraction of people employed explains about a third of the difference in work hours between the United States and France and Germany, and about 60 percent of the difference between the United States and Italy. If you take the difference in the number of weeks worked per year, it explains a little more than a third of the difference between the United States and France and Germany, and a little less than a third of the difference with Italy. And, the difference between hours per worker, explains about a quarter of the difference between the United States, with France and Germany, and not much of the difference with Italy. In the case of Italy, it is in particular the case that very few women work. Women work more everywhere than they used to--but this is even truer in the United States than elsewhere.
There is a very strong relationship between the marginal tax rate and the number of hours worked but also between the number of the hours worked and the percentage of the population covered by a collective bargaining agreement. This is also because union membership and tax rates are also correlated. We must therefore identify the direction of causation.
On the U.S. state level, there is no relationship between hours and taxes, but there is between hours and union density, which seems to dominate marginal tax rates as an explanator.
The number of legally mandated holidays explains 80 percent of the difference between the United States and Europe of work hours per employee. Unions started to actively demand reduced working hours as unemployment rose in Europe. The stated reason was that if all worked less that there would then be more work left for others–as if there was a limited amount of work to go around. Rhetoric of “work less, work all” had much effect, but it was not politically correct to increase wages in the inflationary 1970s. In France, there was a collapse in working hours after Francois Mitterand’s 1982 presidential election victory – not because taxes went up, but because trade unions were increasingly accommodated by policy.
Unions are increasingly dominated by older workers and are becoming unions of retirees (and those close to retirement), so I agree with Steve Davis’ explanation in some ways.
Culture does come into the equation, insofar as if your friends and family get more vacation, then the utility of your own vacation increases complementarily. In Italy, vacations are done with huge groups of friends and family; whereas in the United States, people tend to vacation alone, so the social multiplier effect is reduced. However, this does not serve to completely reconcile micro and macro elasticities.
Paul Krugman, in his infinite wisdom, decided to talk about the paper, and picked up on the only left-wing thing that was in it. If you ask a German “would you like to work less and be paid less,” they would say “yes”. And, if you ask Americans “would you like to work more and be paid more,” they would say “yes.” So, maybe unions provide a coordination device.
The data “what do you do with your time” can be quite inaccurate. Does cooking count as work or leisure? It is hard to use such data, which can be fairly unreliable. For instance, if you go to Paris in August, it is hard to argue that Europeans take less leisure time.
Kevin Hassett: Is it possible that the union variable has more effect in the short run and the tax rate in the long run?
Alberto Alesina: Sure. The long-run effect of the tax rate, which Steve Davis emphasized, is an important point. It is hard to disentangle the effects of big government and big union membership, as they often go together. Taxes stayed stable in the 1980s, but work hours kept falling.
Steve Davis: We do not have many data points from which to draw inferences, especially in the long run. I have therefore tried to use auxiliary evidence that is helpful to disentangle questions. The lack of job growth in France and Germany in these service sector activities fits easily into the tax story that I have illustrated.
Alberto Alesina: The reason why the service sector has not grown in Europe is because small businesses are heavily regulated. This is not explained by taxes or unions. Service sector growth is heavily regulated, and the lack of growth is not the result of taxes, but of barriers to entry.
Kevin Hassett: If unions bid up the cost of labor and taxes bid up the cost of labor, is it right to think that they ought to have analogous effects?
Steve Davis: It is easier to tell if there is a centralized collective bargaining system. The evidence for unions and collective choice mechanisms is interesting, but where choices are made individually taxes will effect decisions more directly. Taxes and social insurance would effect whether it is an individual or collective choice environment.
Kevin Hassett: If I take a dollar from you and give it back with interest when you are sixty-five, that is not really a tax, is it?
Steve Davis: Well, with many of these tax systems and pensions, if you work, you are actually reducing the present value of your retirement.
Kevin Hassett: So, the problem is not the size of the social insurance program, but the distortion at the margin, near retirement. Does this not create a problem for the broad cross-country comparisons?
Steve Davis: This is true. It is hard to measure the right tax variable – particularly if this might be different for a thirty-one-year-old and an sixty-one-year-old.
Alberto Alesina: The average age for college graduation, in Italy, is twenty-eight. This fact is startling, and is both the cause and result of youth unemployment. There are no incentives to finish college (because it is free), but also because it is difficult to find a job. Unions are dominated by older workers, so they do not particularly care about younger workers. There is some evidence that union density is positively correlated with youth unemployment. The argument that the effect of taxes is mediated by collective choice mechanisms in Europe is a very valid point. I have never seen unions demand reduced working hours as a result of taxes reducing their incentives to work. The rhetoric was “work less, work more.” Also, the implication of Steve Davis’s argument is that if taxes went down in France, there would be fewer vacation time in France--that there would be two weeks of vacation instead of six. I just do not see this happening--it is too much engrained in the culture.
Kevin Hassett: Steve Davis had some evidence that in some countries the tax rates and working hours reversed.
Alberto Alesina: In Ireland, a lot of things have changed, in terms of its market culture–not just taxes. I am not against taxes, but I do not believe that it is the whole story. I believe that it is 30 percent of the story, whereas he believes that it is 90 percent.
Steve Davis: Well, I do not believe that it is the whole story, but it is the most important factor. I would like to introduce some data based on time-use surveys, rather than the standard household surveys--trying to get how much time people spend working, rather than just time at work. This suggests that Americans are taking considerably more leisure than they were four years ago, and that they have enjoyed some of their increased earnings in the form of more leisure. It is not the case that Americans are just working harder--they might be spending as much time working in the market, but they are spending less time working at home.
Kevin Hassett: There is strong evidence that Americans have more capital intensive home production. For instance, they are more likely to have washing machines, and are less likely to have to go to the laundromat. In fact, a person under the poverty line in the United States has more of these consumer durables than the average Frenchman--therefore they have more leisure, since they are more efficient at home production.
In summary you agree that a year from now, if you had a change in the tax rate that we would not see much difference in working hours, but Steve Davis believes that maybe twenty (or even five) years from now, we would–whereas Alberto Alesina believes that other factors would hold this divergence in working hours in place, as they do currently.
AEI research assistant Chris Pope prepared this summary.