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Labour Supply: a Review of Alternative Approaches A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Blundell, Richard; MaCurdy, Thomas Working Paper Labour supply: a review of alternative approaches IFS Working Papers, No. W98/18 Provided in Cooperation with: Institute for Fiscal Studies (IFS), London Suggested Citation: Blundell, Richard; MaCurdy, Thomas (1998) : Labour supply: a review of alternative approaches, IFS Working Papers, No. W98/18, Institute for Fiscal Studies (IFS), London, http://dx.doi.org/10.1920/wp.ifs.1998.9818 This Version is available at: http://hdl.handle.net/10419/90853 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu LABOUR SUPPLY: A REVIEW OF ALTERNATIVE APPROACHES Richard Blundell Thomas MaCurdy THE INSTITUTE FOR FISCAL STUDIES Working Paper Series No. W98/18 Chapter 27 LABOR SUPPLY: A REVIEW OF ALTERNATIVE APPROACHES RICHARD BLUNDELL* University College London and Institute for Fiscal Studies THOMAS MACURDY* Department of Economics and The Hoover Institution, Stanford University Contents Abstracts 1560 JEL codes 1560 1 Introduction 1560 2 How have tax and welfare policies changed? 1563 2.1 US tax and welfare programs 1564 2.2 UK tax and welfare programs 1569 3 Recent empirical trends 1572 3.1 Data sources 1574 3.2 Participation 1577 3.3 Hours of work 1580 3.4 Real wages 1584 4 A framework for understanding labor supply 1586 4.1 The static labor supply model 1587 4.2 Multiperiod models of labor supply under certainty 1591 4.3 Multiperiod models of labor supply under uncertainty 1596 4.4 Basic empirical speci®cations 1598 4.5 Which elasticities for policy evaluation? 1603 5 Policy reforms and the natural experiment approach 1607 5.1 The natural-experiment approach and the difference-in-differences estimator 1608 5.2 Does the difference-in differences estimator measure behavioral responses? 1613 5.3 A review of some empirical applications 1615 6 Estimation with non-participation and non-linear budget constraints 1617 6.1 Basic economic model with taxes 1618 * We would like to thank John Pencavel for providing the US data, Christian Dustmann for the German data, Howard Reed for the British data, and Lennart Flood for the Swedish data. Jed DeVaro and Mika Kuismanen provided able research assistance and many helpful comments. We also thank Soren Blomquist, James Heckman, Ian Walker and Valerie Lechene for comments on sections of earlier drafts. Blundell thanks the ESRC Centre for the Microeconomic Analysis of Fiscal Policy at IFS for ®nancial support. MaCurdy gratefully acknowledges research support from NIH grant HD32055-02. Opinions expressed in this chapter are those of the authors and do not represent the of®cial position or policy of any agency funding this research. Handbook of Labor Economics, Volume 3, Edited by O. Ashenfelter and D. Card q 1999 Elsevier Science B.V. All rights reserved. 1559 1560 R. Blundell and T. MaCurdy 6.2 Instrumental-variable estimation 1622 6.3 Maximum likelihood: convex differential constraints with full participation 1626 6.4 Maximum likelihood: convex piecewise-linear constraints with full participation 1629 6.5 Maximum likelihood: accounting for ®xed costs of participation and missing wages 1635 6.6 Welfare participation and non-convex budget constraints 1638 6.7 An approach for computational simpli®cation and discrete hours choices 1643 6.8 Survey of empirical ®ndings for non-linear budget constraints models 1644 7 Family labor supply 1657 7.1 The basic economic model of family labor supply 1657 7.2 The collective model of family labor supply 1661 7.3 Some empirical ®ndings for the family labor supply model 1665 8 Structural dynamic models 1672 8.1 The standard intertemporal labor supply model with participation 1672 8.2 Learning by doing and human capital 1676 8.3 Habit persistence 1680 8.4 Review of empirical results for structural dynamic models 1680 9 Closing comments 1684 Appendix A. Speci®cations of within-period preferences 1686 References 1689 Abstract This chapter surveys existing approaches to modeling labor supply and identi®es important gaps in the literature that could be addressed in future research. The discussion begins with a look at recent policy reforms and labor market facts that motivate the study of labor supply. The analysis then presents a unifying framework that allows alternative empirical formulations of the labor supply model to be compared and their resulting elasticities to be interpreted. This is followed by critical reviews of alternative approaches to labor-supply modeling. The ®rst review assesses the difference- in-differences approach and its relationship to natural experiments. The second analyzes estimation with non-linear budget constraints and welfare-program participation. The third appraises develop- ments of family labor-supply models including both the standard unitary and collective labor-supply formulations. The fourth brie¯y explores dynamic extensions of the labor supply model, character- izing how participation decisions, learning-by-doing, human capital accumulation and habit forma- tion affect the analysis of the lifecycle model. At the end of each of the four broad reviews, we summarize a selection of the recent empirical ®ndings. The concluding section asks whether the developments reviewed in this chapter place us in a better position to answer the policy-reform questions and to interpret the trends in participation and hours with which we began this review. q 1999 Elsevier Science B.V. All rights reserved. JEL codes: J21; J22; J24; C21; C24 1. Introduction Consistent with its tradition, research on labor supply during the past decade has been at the forefront of developments in empirical microeconomics. At the same time, an impor- tant component of this research has rebuffed sophisticated estimation approaches in favor Ch. 27: Labor Supply: a Review of Alternative Approaches 1561 of simple methods for evaluating behavioral responses underlying hours-of-work deci- sions. The attention devoted to the study of labor supply arises from intense interests in assessing the consequences of a wide array of public policies, ranging from tax and welfare programs to the alteration of institutional features of labor markets. A further motivation concerns the curiosity of economists in explaining the factors underlying the dramatic changes in employment patterns that have occurred in recent years, trends that show no evidence of stabilizing in the near future. After presenting a brief overview of the phenomena stimulating recent analyses of labor supply, this chapter pursues its main purpose of reviewing the empirical developments and ®ndings produced by this research. It focuses on work done since the surveys of Pencavel (1986) and Killingsworth and Heckman (1986), which ably summarized the labor supply literature in the previous Handbook of Labor Economics. We draw widely on existing research in the labor supply literature. Our discussion of methodological developments presents simpli®ed examples to highlight essential ideas, not attempting to attribute each development to speci®c authors and, thus, omitting most references in this discussion. We do not claim originality in this survey, and our discussion of applications refers to many of the studies that have made the major contributions to this research area since the earlier Handbook surveys. It is inevitable that we have omitted references and we apologize for such omissions. The in¯uence of governmental programs on people's employment and hours of work is often a critical consideration in the design of policies. Indeed, the primary objective of many recent reforms in both tax and welfare programs in North America, the UK, Scan- dinavia and other parts of Europe has been to encourage participants to increase their work effort. Few decades match the most recent in terms of how much change has occurred in tax and welfare policies. Understanding labor supply behavior is vital in formulating proposals that build in work incentives while providing income support. This chapter begins with a cursory description of how tax and welfare policies have changed in recent years, considering how these changes enter the picture of labor supply and its empirical analyses. For this discussion, we focus on reforms in the US and the UK. This is not simply because of our own local knowledge but also because these two countries have been at the forefront of introducing welfare and tax reforms designed to encourage work effort ± in
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