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Are Micro and Macro Labor Supply Elasticities Consistent? a Review of Evidence on the Intensive and Extensive Margins

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Are Micro and Macro Labor Supply Elasticities Consistent? a Review of Evidence on the Intensive and Extensive Margins Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins The Harvard community has made this article openly available. Please share how this access benefits you. Your story matters Citation Chetty, Raj, Adam Guren, Day Manoli, and Andrea Weber. 2011. Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins. American Economic Review 101(3): 471–475. Published Version doi:10.1257/aer.101.3.471 Citable link http://nrs.harvard.edu/urn-3:HUL.InstRepos:11878970 Terms of Use This article was downloaded from Harvard University’s DASH repository, and is made available under the terms and conditions applicable to Other Posted Material, as set forth at http:// nrs.harvard.edu/urn-3:HUL.InstRepos:dash.current.terms-of- use#LAA Are Micro and Macro Labor Supply Elasticities Consistent? A Review of Evidence on the Intensive and Extensive Margins By Raj Chetty, Adam Guren, Day Manoli, and Andrea Weber Macroeconomic models of fluctuations in gin elasticities, the extensive margin elas- hours of work over the business cycle or ticity is often treated as a free parameter across countries imply much larger labor that is calibrated purely to match macro- supply elasticities than microeconometric es- economic moments. But micro estimates timates of hours elasticities. Understanding are equally useful in calibrating extensive this divergence is critical for questions rang- margin responses: the marginal density of ing from the sources of business cycles to the the reservation wage distribution that deter- impacts of tax policy. Since the discrep- mines the impacts of macroeconomic varia- ancy between micro and macro elasticities tion on employment also determines the im- was recognized in the 1980s, economists have pacts of quasi-experiments such as tax policy made significant advances in understanding changes on employment rates. labor supply. For instance, macroecono- We find that micro estimates are consis- mists have developed models of indivisible tent with macro estimates of the steady- labor in which extensive-margin responses state (Hicksian) elasticities relevant for make aggregate-hours elasticities larger than cross-country comparisons on both the ex- intensive-margin elasticities (Richard Roger- tensive and intensive margins. However, mi- son 1988, Gary D. Hansen 1985, Lars cro estimates of intertemporal substitution Ljungqvist and Thomas J. Sargent 2006). (Frisch) elasticities are an order of magni- Meanwhile, microeconomists have amassed tude smaller than the values needed to ex- a large body of evidence on intensive (hours plain business cycle fluctuationsin aggregate conditional on employment) and extensive hours by preferences. Quasi-experimental (participation) labor supply elasticities. estimates of extensive margin intertempo- The goal of this paper is to evaluate ral substitution elasticities are around 0.25, whether state-of-the-art macro models fea- whereas leading pure equilibrium macro turing indivisible labor are consistent with models imply intertemporal substitution ex- modern quasi-experimental micro evidence. tensive margin elasticities around 2. Hence, To do so, we consider evidence on both the key puzzle to be resolved is why employ- the intensive and extensive margins. Al- ment rates fluctuate so much over the busi- though macro models are now calibrated ness cycle relative to what one would pre- to match micro estimates of intensive mar- dict based on the impacts of tax changes on employment rates — that is, why micro and macro estimates of the Frisch extensive mar- Chetty: Harvard University Department of Eco- nomics and NBER, 1805 Cambridge St., Cam- gin elasticity are so different. bridge, MA 02138 (email: [email protected]). Guren: Harvard University Department of Economics, I. Terminology 1805 Cambridge St., Cambridge, MA 02138 (email: [email protected]). Manoli: UCLA Department of Economics, RAND, and NBER, 8283 Bunche Hall It is helpful to establish conventions about Box 951477, Los Angeles, CA 90095 (email: dsman- terminology given the various elasticity con- [email protected]). Weber: University of Mannheim Department of Economics, L7, 3-5, 68131, Mannheim, cepts used in the micro and macro litera- Germany (email: [email protected]). Thanks tures. We distinguish between elasticities to Peter Ganong and Jessica Laird for outstanding re- based on the margin of response (extensive search assistance and Richard Blundell, Greg Bruich, vs. intensive) and the timing of response (in- David Card, John Friedman, Bob Hall, Greg Mankiw, Richard Rogerson, Robert Shimer, and Danny Yagan tertemporal substitution vs. steady state). for helpful comments. There are four elasticities of interest: steady- 1 2 PAPERSANDPROCEEDINGS MAY2011 Table 1– Micro vs. Macro Labor Supply Elasticities Intensive Margin Extensive Margin Aggregate Hours Steady State micro 0.30 0.26 0.56 (Hicksian) macro 0.38 0.14 0.51 Intertemporal micro 0.54 0.28 0.82 Substitution (Frisch) macro [0.54] [2.30] 2.84 Note: Each cell shows a point estimate of the relevant elasticity based on meta analyses of existing micro and macro evidence. Micro estimates are identified from quasi-experimental studies; macro estimates are identified from cross- country variation in tax rates (steady state elasticities) and business cycle fluctuations (intertemporal substitution elasticities). The aggregate hours elasticity is the sum of the extensive and intensive elasticities. Macro studies do not always decompose intertemporal aggregate hours elasticities into extensive and intensive elasticities. Therefore, the estimates in brackets show the values implied by the macro aggregate hours elasticity if the intensive Frisch elasticity is chosen to match the micro estimate of 0.54. Sources are described in the appendix. state extensive, steady-state intensive, in- country differences in aggregate hours imply tertemporal extensive, and intertemporal in- an elasticity of 3 in a representative-agent tensive. We use the terms “micro” and model, whereas Steven J. Davis and Mag- “macro” elasticities to refer to the sources nus Henrekson (2005) estimate an elasticity of variation used to estimate the elasticities. of 0.33 using similar data. The difference The elasticity of aggregate hours —the rele- is almost entirely because Prescott reports a vant parameter for calibrating a representa- Frisch elasticity whereas Davis and Henrek- tive agent model —is the sum of the extensive son report a Hicksian elasticity. and intensive margin elasticities, weighted by hours of work if individuals have hetero- II. Comparing Micro and Macro geneous preferences (Richard Blundell, An- Estimates toine Bozio, and Guy Laroque 2011). We summarize the micro and macro evi- The macro literature uses the term “macro dence on the extensive and intensive margins elasticity” to refer to the Frisch elasticity in Table 1. The rows of consider steady- of aggregate hours and the term “micro state (Hicksian) vs. intertemporal substitu- elasticity” to refer to the intensive-margin tion (Frisch) elasticities, while the columns elasticity of hours conditional on employ- compare intensive margin (hours conditional ment (e.g. Edward Prescott 2004, Roger- on employment) and extensive margin (par- son and Johanna Wallenius 2009). We ticipation) elasticities. Within each of the use different terminology here for two rea- four cells, we report micro and macro esti- sons. First, the intensive-margin is no more mates of the elasticity based on (unweighted) “micro” than the extensive margin; both means of existing studies. We also calculate reflect household-level responses and both aggregate hours elasticities by summing the have been estimated using micro data. Sec- extensive and intensive elasticities.1 ond, although the Frisch elasticity is crit- There are wide confidence intervals asso- ical for understanding business cycle fluc- ciated with each of the point estimates in tuations, it is not relevant for evaluating Table 1, as well as methodological disputes the steady-state impacts of differences in about the validity of some of the studies. taxes across countries. The Frisch (mar- Therefore, the estimates should be used to ginal utility constant) elasticity controls in- gauge orders of magnitude: differences of 0.1 tertemporal substitution responses to tem- between elasticity estimates could be due to porary wage fluctuations,while the Hicksian (wealth constant) elasticity controls steady- 1 This calculation requires that preferences are ho- state responses and the welfare cost of taxa- mogenous. If some groups work few hours and also have higher extensive elasticities, as suggested by existing ev- tion. This distinction is quite important in idence, this will yield an upper bound on the aggregate practice. Prescott (2004) reports that cross- hours elasticity (Blundell, Bozio, and Laroque 2011). VOL. 101 NO. 2 MICRO AND MACRO ELASTICITIES: INTENSIVE AND EXTENSIVE MARGINS 3 noise or choice of specification, while differ- of steady-state aggregate hours elasticities ences of 1 reflect fundamental discrepancies. match once one accounts for extensive mar- Steady-State Elasticities. On the exten- gin responses and the attenuation of inten- sive margin, Chetty et al. (2011b) conduct sive margin micro elasticities due to opti- a meta-analysis of quasi-experimental stud- mization frictions. ies that span a broad range of countries, de- Intertemporal Substitution Elasticities. mographic groups, time periods,
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