Title: Coping With Challenges Ahead: The Role of Hours Worked Europe vs' United States Edward C' Prescott A
1Coping With Challenges Ahead The Role of Hours
Worked Europe vs. United StatesEdward C.
PrescottArizona State University and Federal
Reserve Bank of MinneapolisJune 2005
2Current Social Security System in Most European
Countries Cannot Be Sustained
- Reason
- 1. Population is aging.
- 2. Big retirement benefits are received by the
old.
3If Labor Supply Inelastic
- Only choices are
- 1. Default on some promises
- 2. Or increase taxes
- 3. Or combination of both
4If Labor Supply Elastic
- Can rebuild the Social Security system in a way
that - 1. Honors all promises
- 2. Makes everyone better off
5Labor Supply Is Highly Elastic 3
- Here I mean AGGREGATE LABOR SUPPLY
- Aggregate and micro labor supply elasticity are
DIFFERENT concepts - Relevant concept for designing tax system is
aggregate labor supply elasticity
6Definition of Aggregate Labor Supply Elasticity
- Holding wealth constant, it is the percentage
change - in aggregate labor supply associated with a 1
- change in the after-tax real wage.
7Evidence That Aggregate Labor Supply Elasticity
Is High
8Business Cycle Evidence
- Finn Kydland and I (1982) found that if and only
if this elasticity is high, about 3, does the
neoclassical growth model quantitatively predict
all the key business cycle facts. (One of the two
papers for which we received the Nobel Prize.) - Many others using dynamic applied general
equilibrium analysis have also (see Cooley 1995
volume).
9Depression Evidence
- Fumio Hayashi and I (2002) find this neoclassical
growth model accounts for the behavior of the
economic aggregates in Japans lost decade of
growth, 1992-2002, if and only if this elasticity
is about 3. - See Kehoe and Prescott Depressions Volume (2002)
for further evidence from a number of other
studies for this number.
10 11Cross-Country Labor Supply and Tax Evidence
- I found that the basic theory and the differences
in tax rates predict the large differences if and
only if this elasticity is about 3. - Americans, Chileans, and Japanese all work over
40 more than Western Europeans because their
marginal tax rates are 40 and not 60 as in
Western Europe.
12Cross-Time Tax Evidence
- I found the reason that labor supply fell by a
third in Europe between the early 1970s and the
mid 1990s was that the average effective tax rate
was increased from 40 to 60. - An implication of this is that increasing tax
rates will not increase tax revenue in Western
Europe.
13Theoretical Evidence
- Rogerson (1984) and Hansen (1985) use theory to
establish that aggregate elasticity is much
greater than individual elasticity. - Provided the margin of labor supply adjustment is
the number of employed and not hours per
employed. - This is the empirically interesting case.
14The Principal Margin of Adjustment Is Fraction
Employed
- Over business cycles
- Over seasons
- Over large adjustments to a new balanced growth
path e.g. growth miracles and depressions - Over the life cycle people retire
15Other Factors Matter The Case of Spain
16Summary
- It is an established scientific finding that
aggregate labor supply is highly elastic - All micro and macro evidence supports this
scientific finding - People respond to incentives
17Mandatory Savings Plan
- For health care and for retirement
- Major medical insurance to take care of major
health expenditures - Survivor and disability insurance
18Welfare Would Increase
- Measure of welfare is lifetime consumption
equivalents. - Welfare would increase by a third.
19What About Government Debt?
- Given need for some place to invest all the
savings, there would have to be a huge national
debt say 6 GDPs paying market returns of 4
real per year. - This debt is implicitly there now with the
pay-as-you-go systems.
20What About Low Birth Rates?
- No problem.
- Conclusions are not sensitive to this conclusion.
21Conclusion
- Mandatory savings accounts are the only way to
provide for retirement. - If there was a switch there would be a huge boom
in Western Europe that would be as big as
Europes postwar boom. - My advice to Germany and France is to follow the
lead of Spain and Sweden.