Policy bubbles alert: can more money reduce child poverty?

Cover: What Money Can't Buy in PAPERBACKSusan Mayer in her book What Money Can’t Buy found very little evidence to support the widely held belief that parental income has a significant effect on children’s life outcomes. Mayer:

  • Challenged the assumption that poverty directly causes poor health, behavioural problems, and a host of other problems for children;
  • Also stated that there was no correlation but a coincidence with a missing third factor, which was jobs; and
  • Found that household conditions are highly responsive to income but how it is spent is what matters more.

These findings were Susan Mayer are of profound importance because far too many people believe the solution to child poverty is to give the poor more money. What could be simpler.

Capitalism have been giving the poor more money for centuries now. This great enrichment dwarfs anything that redistribution and egalitarian politics and the welfare state has done in the 20th century.

Mayer said that her findings do not endorse massive cuts in welfare:

My results do not show that we can cut income support programs with impunity…

Indeed, they suggest that income support programs have been relatively successful in maintaining the material living standard of many poor children.

Mayer found that non-monetary factors play a bigger role than previously thought in determining how children  overcome disadvantage as she explains.

Parent-child interactions appear to be important for children’s success, but the study shows little evidence that a parent’s income has a large influence on parenting practices.

Mayer said that if money alone were responsible for overcoming such problems as unwed pregnancy, low educational achievement and male idleness, states with higher welfare benefits could expect to see reductions in these problems. In reality,

once we control all relevant state characteristics, the apparent effect of increasing Aid to Families with Dependent Children benefits is very small

Mayer is of the view that many of the activities that improve children’s outcomes are more related to parenting choices than to income:

They mainly reflect parents’ tastes and values.

Books appear to benefit children because parents who buy a lot of books are likely to read to their children.

Parents who do not buy books for their children are probably not likely to read to them even if the books are free, and parents who do not take their children on outings may be less likely to spend time with them in other ways.

Among her findings, which have largely survive the test of time, are:

  • Higher parental income has little impact on reading and mathematics test scores.
  • Higher income increases the number of years children attend school by only one-fifth of a year.
  • Higher income does not reduce the amount of time sons are idle as young adults.
  • Higher income reduces the probability of daughters growing up to be single mothers by 8 to 20 percent.

Mayer found that as parents have more money to spend, they usually spend the extra money on food, especially food eaten in restaurants; larger homes; and on more automobiles.

As a result, children are likely to be better housed and better fed, but not necessarily better educated or better prepared for high-income jobs. This is her key conclusion about what money can and cannot buy:

If we are asking specifically about the relationship between parental income and children’s outcomes, a fairly clear answer is emerging: parental income itself has a modest effect on children’s outcomes and this effect is not necessarily greater for children from poor families compared to children from rich families.

Mayer’s analysis in many ways reflects her own life story. She divorced in the mid-1970s and had so many money troubles that she had trouble paying the rent.

She remarried in the early 1980s and had a second child. This second child at a comfortable middle-class upbringing. The mother went on to complete a Ph.D. and ended up as head of the Harris School of Public Policy at the University of Chicago.

Mayer noticed that both of her children turned out pretty much the same despite the older child was raised in poor circumstances. The common factor to this success was they had the same mother.

Why Lefties Make Less – The Atlantic

Why Lefties Make Less – The Atlantic.

Recessions as reorganisations

Most models of the shape of recoveries draw on a learning process. A long tradition in business cycle theory holds that limited knowledge of relative price changes can temporarily disrupt labour demand and supply because of errors in wage and price perceptions (Alchian 1969; Sargent 2007; Hellwig 2008).

Pricing, investment and production plans are made on the basis of incomplete and conflicting knowledge of constantly changing aggregate, industry and local conditions. Firms and workers will over- or under-supply when they misperceive wages and prices.

With imprecise information, it takes time for employers and workers to sort out temporary from permanent shifts in demand and supply, inflation-driven changes from real changes in prices and input costs, and general changes from the local changes that may be more important to particular firms. As Hayek explained in his Nobel prize lecture:

The true, though untestable, explanation of extensive unemployment ascribes it to a discrepancy between the distribution of labour (and the other factors of production) between industries (and localities) and the distribution of demand among their products.

This discrepancy is caused by a distortion of the system of relative prices and wages. And it can be corrected only by a change in these relations, that is, by the establishment in each sector of the economy of those prices and wages at which supply will equal demand.

Recoveries are shaped by the speed of entrepreneurial learning about the new labour and product market conditions, the relative cost of adjusting capital and labour rapidly or slowly and the costs and benefits of labour market search. This new learning is necessary because the old constellation of prices and wages is no longer valid.

It was a misdirection of resources brought about by the initial inflationary firm, as Hayek explained in a visit to Australia in 1950:

During a process of expansion the direction of demand is to some extent necessarily different from what it will be after expansion has stopped.

Labour will be attracted to the particular occupations on which the extra expenditure is made in the first instance.

So long as expansion lasts, demand there will always run a step ahead of the consequential rises in demand elsewhere.

And in so far as this temporary stimulus  to demand in particular sectors leads to a movement of labour, it may well become the cause of unemployment as soon as the expansion comes to an end…

If the real cause of unemployment is that the distribution of labour does not correspond with the distribution of demand, the only way to create stable conditions of high employment which is not dependent on continued inflation (or physical controls), is to bring about a distribution of labour which matches the manner in which a stable money income will be spent.

This depends of course not only on whether during the process of adaptation the distribution of demand is approximately what it will remain, but ‘also on whether conditions in general are conducive to easy and rapid movements of labour.

In a recession, employers and workers do not immediately know that demand has fallen elsewhere as well as in their own local markets and recognise the need to adjust to their poorer prospects everywhere, and it is not known how long the drop in demand will last (Alchian and Allen 1973).

The cost of learning about available opportunities restricts the speed of a recovery. Workers and entrepreneurs must gather information on the new state of demand and the location and nature of new opportunities. This information is costly and is quickly made obsolete by further changes, and the cost of acquiring information is more costly the faster the information is sought to be acquired (Alchian 1969; Alchian and Allen 1967).

The process of recovering from a recession would be a faster process if the new constellation of wages and prices that are the best alternative uses of resources was known immediately and was credible to firms and workers (Alchian and Allen 1973).

Workers and employers must first have sufficient time to discover what new knowledge they now need to know to serve their interests well, leave enough room for the unforeseeable and keep their knowledge fresh in ever-changing markets.

New wage levels must be created by workers and employers testing and retesting in the labour market the new relative scarcities of labour. Imbalances between the allocation of labour supply and demand to different firms and sectors and the new level and pattern of consumer demand are gradually remedied by changes in relative prices and wages, layoffs, business closures and job search.

Prices are a signal wrapped in an incentive. Growing demand induces higher employment and rising wages. Wages stagnate, and there are layoffs where there is an excess supply.

These changes give the unemployed an incentive to move to new uses and entrepreneurs to profitably hire the unemployed. The ensuing reorganisations are time-consuming and information-intensive because a job seeker and an employer with an apt vacancy take time to find each other.

Prices and wages must change sufficiently for firms to profitably create new jobs. New jobs require time to plan and build new job capital. This is the human, physical and organisational capital underlying a new job. There are also job creation costs when reopening existing positions that were mothballed during the downturn.

How is this to be done? Hayek explained again in 1950 in his speech in Australia:

Full employment policies as at present practised attempt the quick and easy way of giving men employment where they happen to be, while the real problem is to bring about a distribution of labour which makes continuous high employment without artificial stimulus possible.

What this distribution is we can never know beforehand. The only way to find out is to let the unhampered market act under conditions which will bring about a stable equilibrium between demand and supply.

Is welfare dependence optimal for whom – part 5: higher abatement rates and labour supply

Paradoxically, the main way of using financial incentives to increase net labour supply of beneficiaries and move more off the benefit is to toughen the benefit abatement regime.

This increase in the abatement rates on welfare benefits for earned income moves more off the benefit and moves more into full-time employment but still with an ambiguous effect on part-time employment. Some may prefer the benefit over their current part-time job.

The notion that tinkering with financial incentives will not have large effects on labour supply and benefit numbers is not new. Increase in the generosity of welfare benefits with increase the number of applicants.

Tinkering with the details of abatement rates and thresholds has ambiguous labour supply effects because exits from welfare are still offset by new entry onto welfare. The netting the labour supply changes of these diverse groups often leads to welfare reform leading to positive but small change in labour supply. Quantitatively, an old finding is the remarkable lack of effects of financial incentives on welfare participation (Moffitt 1992, 2002).

Under a move up to a 100 per cent benefit abatement rate as shown in Figure 1; arrow 1 in Figure 1 shows that some who were working part-time will now find not working at all to be the more attractive option. The new 100 per cent benefit abatement rate reduces their take-home pay but they enjoy more leisure time.

Figure 1: the labour supply effects of an increase to a 100 per cent benefit abatement rate

hundred percent abatement rates diagram

Arrow 2 in Figure 1 shows that some part-time workers increase their working hours because working a little more mitigates the reduction in their take-home pay and allow some leisure time.

Arrow 3 in Figure 1 shows that some part-timers return to full-time working hours because of the revised leisure-labour trade off that now makes a somewhat higher take-home pay worthwhile despite reduced leisure time.

Whether net labour supply increases or falls after a rise in the benefit abatement rate to 100 per cent depends on the relative numbers of workers at different points on the budget constraint that are working full-time, not working, and working part-time and the magnitudes of their responses.

Some will stay as they are working either full-time, not working or working part-time. Others supply more labour. Working more hours may increase their take-home pay depending on how productivity they are.

Some part-timers will move to full-time in low paid jobs with take-home pay because of the loss of benefit income, they will enjoy less leisure time and there can be additional costs such as child care.

More productive workers in better paid jobs will take home more in pay by moving to full-time but will enjoy less leisure time. Some workers that were previously working part-time stop working and rely in welfare benefits.

If reduced welfare dependence is the objective, high abatement rates and low abatement thresholds are the path to follow. With a move to 100 per cent abatement of benefits, some leave the welfare system but no one joins it because of the higher abatement rate.

Less generous abatement will see some who claim the benefit while working part-time move to a lower take-home pay. Some will be on a higher take-home pay working full-time. The net labour supply effect is ambiguous because some leave work altogether while others work more hours.

The net labour supply depends on the relative numbers at different points on the budget constraint working full-time, not working, or working part-time and the magnitudes of their respective individual labour supply responses. Some people will stay as they are working full-time, not working or working part-time.

No one who previously did not work is worse off under the benefit abatement rate increase to 100 per cent because they are unaffected by abatement. Some who were working part-time and previously claiming the benefit take-home less but enjoy more leisure as shown by arrow 2 in Figure 1. The remaining part-time workers now take-home more pay but enjoy less leisure because they are working more hours and even full-time as shown by arrow 3 in Figure 1.

The blogs so far

part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

part-3-abatement-free-income-thresholds-and-labour-supply

part-4-in-work-tax-credits-and-labour-supply

part-5-higher-abatement-rates-and-labour-supply

part-6-mandatory-work-requirements-and-labour-supply

part-7-the-role-of-tagging-in-welfare-benefits-system

What is the main driver of a gender wage gap?

Richard Epstein on the relative simplicity of labour markets

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Tom Sargent’s Keynote Address BYU CPEC 2012 on taxation and redistribution

Charles Murray and the OECD’s Trends in Income Inequality and its Impact on Economic Growth – IQ, signalling, over-education and plain bad career advice

Charles Murray has been cooking with gas lately – on fire. One of his points is too many go to college. Murray points out that succeeded at college requires an IQ of at least 115 but 84% of the population don’t have this:

Historically, an IQ of 115 or higher was deemed to make someone “prime college material.”

That range comprises about 16 per cent of the population.

Since 28 per cent of all adults have BAs, the IQ required to get a degree these days is obviously a lot lower than 115.

Those on the margins of this IQ are getting poor advice to go to college. Murray argues that other occupational and educational choices would serve them better in light of their abilities and likelihood of succeeding at college. Moreover, Murray is keen on replacing college degrees with certification after shorter periods of study such as in the certified public accountants exam.

Murray believes a lot of students make poor investments by going on to College, in part, because many of them don’t complete their degrees:

…even though college has been dumbed down, it is still too intellectually demanding for a large majority of students, in an age when about 50 per cent of all high school graduates are heading to four-year colleges the next fall.

The result is lots of failure. Of those who entered a four-year college in 1995, only 58 per cent had gotten their BA five academic years later.

Murray does not want to abandon these teenagers:

Recognizing the fact that most young people do not have ability and/or the interest to succeed on the conventional academic track does not mean spending less effort on the education of some children than of others.

…Too few counsellors tell work-bound high-school students how much money crane operators or master stonemasons make (a lot).

Too few tell them about the well-paying technical specialties that are being produced by a changing job market.

Too few assess the non-academic abilities of work-bound students and direct them toward occupations in which they can reasonably expect to succeed.

Worst of all: As these students approach the age at which they can legally drop out of school, they are urged to take more courses in mathematics, literature, history and science so that they can pursue the college fantasy. Is it any wonder that so many of them drop out?

To add to that, he is in the Bryan Caplan School: education is often an elaborate former of signalling for many degrees. Murray says that college is a waste of time because:

Outside a handful of majors — engineering and some of the sciences — a bachelor’s degree tells an employer nothing except that the applicant has a certain amount of intellectual ability and perseverance.

Even a degree in a vocational major like business administration can mean anything from a solid base of knowledge to four years of barely remembered gut courses.

If the OECD is to be believed, that not enough people are going to college from lower middle class families, obviously IQ is not one of the constraints on access to college Charles Murray suggested it to be.

 

The growing strength of the case that education is a form of signalling is a literature that the now famous OECD paper reviewed, found wanting, but did not have time to discuss in the working paper.

Another contemporary theme the OECD paper reviewed, found wanting, but did not have time to discuss is a large number of graduates who end up holding jobs that do not require a university education – going to college:

About 48 per cent of employed U.S. college graduates are in jobs that the Bureau of Labor Statistics (BLS) suggests requires less than a four-year college education.

Eleven per cent of employed college graduates are in occupations requiring more than a high-school diploma but less than a bachelor’s, and 37 per cent are in occupations requiring no more than a high-school diploma.

The proportion of overeducated workers in occupations appears to have grown substantially; in 1970, fewer than one per cent of taxi drivers and two per cent of fire-fighters had college degrees, while now more than 15 per cent do in both jobs

All in all, the OECD has gone into the dragons den by backing the accumulation of human capital as its mechanism to link inequality with lower growth. No matter how you spin it, this linking of lower economic growth to greater inequality through financial constraints on the accumulation of human capital by the lower middle class was a bold hypothesis.

The case for investing more in education is not a slam dunk. Higher education – university or polytechnic – is a rat race that many don’t need to join.The case for the government paying a great many more to join that rat race is rather weak.

Trends in Income Inequality and its Impact on Economic Growth – OECD – is it all about not enough graduates – updated?

The analysis of the OECD published overnight depends crucially upon how greater inequality reduces the ability of the lower income families to invest in human capital.

The OECD theory of inequality and lower growth is there is a financing constraint because of inequality that reduces economic growth because of less human capital accumulation by lower income families.

Proportion of adults aged 25–64 years with an educational qualification of at least upper secondary level and tertiary level, 1991–2009

Figure K4.1 Proportion of adults aged 25–64 years with an educational qualification of at least upper secondary level and tertiary level, 1991–2009

In a nutshell, not enough people are going to university. Apparently,  the explosion in tertiary educational attendance over the last generation, an increase of about 150%  for the adult population aged 25 to 64, was just not good enough.

But what about adults aged 25 to 34, recent graduates, how many of them are there?

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There was an explosion of young New Zealanders in the late 1990s who qualified for a degree from a university or diploma from a Polytech.

Under the hypothesis of the OECD about financial constraints retarding the accumulation of human capital among the lower middle class – the fourth decile of the income distribution –  even more young New Zealanders should have gone to university or Polytech.

Are there many New Zealanders left who are qualified and suited to tertiary education who do not go?

That is the crux of the OECD position: not enough lower-middle-class New Zealanders go on to obtain higher education and upgrade their skills because of financial constraints in a country was in interest free student loans,  means tested student allowances, and the government subsidises for 75% of all tuition fees. Tuition fees only equal 25% of the actual cost  and any one can get a student loan to cover this fee.

Gender wage gap or asymmetric marriage premium?

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Some economics of the marriage bars (and mandatory retirement ages)

Up until 1966, women had to quit from the Australian Public Service when they married! The bar was repealed in 1966 with a private members bill by Bill Hayden.

Some hid their marriages for years, hiding their rings before they got to work.

One woman remained unmarried and bore four children. She managed this by timing her annual leave to cover the births.

While her personnel area was co-operative, they forced her to resign her middle management position when she decided to make an honest man of her de facto husband by marrying the father of their children.

Claudia Goldin found that marriage bars were policies adopted by firms and local school boards, from about the early 1900’s to 1950. They fired single women when they married and would not not to hire married women.

The marriage bar, which had at its height affected 751 of all local school boards in the USA and more than 50% of all office workers, was virtually abandoned in the 1950’s when the cost of limiting labour supply greatly increased.

When marriage bars disappeared, Goldin found that older female workers in the mid-1950’s were suddenly praised for their “maturity, reliability, neat appearance, and less chatty nature”.

In retail trades, and especially in suburban retail shops, Goldin found that older married women with absolutely no previous training were now the “ideal employee”; the middle-class woman were “naturally courteous” and “well-bred,” and who did not have to work became the preferred recruits of the major department stores. the best female employee was, in the words of a Sears, Roebuck, and Co. officer

a married woman with a mortgage on her house and her children partially raised

These sudden changes in the attitude of employers towards the recruitment of women of different ages and marital status suggests that the previous personnel policies were disciplined by competition.

Marriage bars, in the private sector, were instituted by large firms with centralised hiring promotion and salary schedules that were often fixed and based on tenure with the firm, and other modern employment practices.

This evidence suggested to Claudia Goldin that firms may have wanted to encourage turnover when earnings rose more rapidly with tenure than productivity. These  employers in firms with rigid wage systems, tied to their workers’ seniority, desired a young, inexperienced work force. Goldin hypothesise that the marriage bar was a socially acceptable way of terminating the employment of young women whose wages would eventually rise to exceed their addition revenue to the firm.

Goldin suggested that the marriage bar had some relationship to seniority pay, as discussed by Edward Lazear.

Under seniority pay, and employees paid less than their productivity in their early years of employment but more in their later years of employment up to say a retirement date.

By back loading salary, the employer could economise on the cost of monitoring the employee’s performance and especially so in jobs where it was hard to evaluate performance. Because of the prize at the end of the road: a large salary paid towards the end of a career, an employee had more reasons to be honest and not to underperform and risk dismissal.

Not all workers may be compensated under long-term seniority pay contracts. Routine office workers, support staff, sales agents, and so on appear to be compensated on a spot basis rather than under long-term incentive contracts.

Workers in these more routine occupations have lower monitoring costs. Their productivity can be more easily and cheaply  measure directly.

There is no need for sophisticated incentive contracts as is the case more often with managerial Employees and workers who hold positions of trust. In both cases , the back loading a salary operates as a bond against poor performance and dishonesty.

Most women entered the workforce by the age of 18 in the mid to early 20th century. They married in their early to mid-20s. This meant that the maximum length of their career with the firm would be 5 to 7, maybe 10 years.

Because these women are often assigned to low skilled clerical duties where there are a few promotion prospects, the productivity of these women did not increase much with time in the job.

To make sure that some women didn’t stay on to receive the seniority based salary increases by not marrying, Goldin found that some firms offered a substantial dowry is to women when they married if that already been with the firm for six years.

These dowries were buying women out of jobs where their wages were rising, but their productivity was stable.

Another advantage of buying women out of their jobs when they married was that the male co-workers didn’t have to be paid a wage premium for less job security can as they themselves could be dismissed on similar grounds.

Marriage bars were found by Goldin to be associated with fixed salary scales, internal promotion, and other personnel practices and they are not associated with piece-rate work.

Subsequent work on mandatory retirement ages in the public private sector found a similar link to both seniority pay and organisational architecture and the the limits of individual managerial discretion over firing.

The organisational architecture of a firm encompasses the assignment of decision rights within the firm, the methods of rewarding individual employees, and the structure of the systems that evaluate the performance of individual employees and business units.

Some larger firms may struggle to administer internal corporate governance structures which permit more local managerial discretion over employment relationship matters and still properly control the costs of a more diverse workforce.

A price of growth in the size of a firm is often the standardisation of products, workforce compositions and terms of employment.

When mandatory retirement was lawful, large firms with centralised personnel structures are more often to be found to have mandatory retirement ages.

The nub of the problem is large firms have several layers of management with fairly strict limits on what each individual line manager can do (Williamson 1975, 1985; Fama and Jensen 1983b).

There must be limits on local managerial discretion because the owners and senior managers set the strategic direction of the firm, the products it sells, and how many workers are employed and on what wages.

Larger firms may struggle with striking the most profitable balance between greater local managerial discretion and effective corporate governance of a large diverse organisation with professional managers and diffuse ownership structures. It will be shown that very large firms promulgate rigid personnel policies while smaller firms are much more flexible in their deals with individual employees.

This balance between local managerial discretion and central control must extend to wages and hours because labour costs make up much of the costs of many firms. Changes in policies on wages and conditions are subject to ratification and monitoring by head office and the corporate board in managerial firms.

This increasing rigid separation of decision management rights from decision control rights as a managerial firm grows will restrict flexibility in terms of employment, including phased retirements. Top level managers and board members both have limited amount of time to allocate, limited spans of control, and will have less and less detailed knowledge of their firm as it grows.

Limits on the degree of local managerial discretion over employment relations in large managerial firms can arise from restrictions on managerial delegations, divided decision making rights, hierarchical approval procedures, and the breath and content of wage and personnel policies. This can include not having a personnel policy on the availability of phased retirements. This gap can be through choice, inertia or attention to other concerns currently of a higher priority.

The discretion of supervisors in large firms over the terms and conditions of employment of individual members of their team may be limited to individual performance ratings (Gibbs and Hendricks 2004).

Smaller firms have more more discretion over retirement ages was is less of a separation of ownership and control, and owners are much more able to be on-site and of balance risks and rewards from innovations.

Good evidence to illustrate the proposition that larger firms prefer rigid rules over discretion in personnel policies comes from the days of mandatory retirement. Mandatory retirements can be viewed as the wholesale substitution of local managerial discretion with a single company-wide rule because larger firms find idiosyncratic decisions to be more costly (Parsons 1997).

Back when they were legal, mandatory retirements are near universal in very large workplaces, but in small to medium size firms, there were flexible retirement polices. Few very large firms reported flexible retirement polices. The smaller firms provided for policies that allowed for exceptions to mandatory retirement rules while most of largest firm reported a policy of zero exceptions to mandatory retirement rules (Parsons 1997).

The line managers in small firms were more willing to allow an older worker to work passed the usual retirement age because they had more delegations with regard to terms and conditions of employment. In addition, in smaller firms, the owners are more likely to be among the management team for the CEO and able to closely supervise the success of the discretionary decisions of junior management over conditions of employment and hiring and firing.

Richard Posner described the engines of women’s liberation

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Involuntary unemployment and the great vacation theories of the great depression and Eurosclerosis – updated again

Most Keynesian economists are convinced that something exists called involuntary unemployment and people can be unemployed through no fault of their own. They will accept the going wage but no employer is willing to offer it to them.

Lucas and Rapping’s (1969) paper, “Real Wages, Employment, and Inflation” provides the micro-foundations for an analysis of the labour suppl. They felt the need to reconcile the existence of unemployment with market clearing and referred to recent work of Armen Alchian (1969) on search explanations of unemployment.

Lucas and Rapping viewed unemployment as voluntary, including the mass unemployment during the great depression (Lucas and Rapping 1969: 748).

Lucas and-Rapping viewed current labour demand as a negative function of the current real wage. Current labour supply was a positive function of the real wage and the expected real interest rate, but a negative function of the expected future wage.

Under their framework, if workers expect higher real wages in the future or a lower real interest rate, current labour supply would be depressed, employment would fall, unemployment rise, and real wages increase.

Lucas and Rapping depicted labour suppliers as rational optimisers who engaged in inter-temporal substitution: working more when current wages were high relative to expected wages. The prevailing Keynesian approach assumed labour supply was passive, and movements in the demand for labour determined changes in employment.

Lucas and Rapping offered an unemployment equation relating the unemployment rate to actual versus anticipated nominal wages, and actual versus anticipated price levels. Unemployment could be the product of expectational errors about wages.

Lucas and Rapping’s model was poor at explaining unemployment after 1933 in terms of job search and expectational errors.

The graph below shows two different series for unemployment in the 1930s in the USA: the official BLS level by Lebergott; and a data series constructed famously by Darby. Darby includes workers in the emergency government labour force as employed – the most important being the Civil Works Administration (CWA) and the Works Progress Administration (WPA).

Once these workfare programs are accounted for, the level of U.S. unemployment fell from 22.9% in 1932 to 9.1% in 1937, a reduction of 13.8%. For 1934-1941, the corrected unemployment levels are reduced by two to three-and-a half million people and the unemployment rates by 4 to 7 percentage points after 1933.

Not surprisingly, Darby titled his 1976 Journal of Political Economy article Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, an Explanation of Unemployment, 1934-1941.

The corrected data by Darby shows stronger movement toward the natural unemployment rate after 1933. Darby concluded that his corrected date are suggests that the unemployment rate was well explained by a job search model such as that by Lucas and Rapping together with the wage fixing under the New Deal that kept real wages up and unemployment high.

Both the Keynesian approach to unemployment and the job search approach to unemployment view workers in emergency government work programs as employed and not as unemployed.

In the late 1970s, Modigliani dismissed the new classical explanation of the U.S. great depression in which the 1930s unemployment was mass voluntary unemployment as follows:

Sargent (1976) has attempted to remedy this fatal flaw by hypothesizing that the persistent and large fluctuations in unemployment reflect merely corresponding swings in the natural rate itself.

In other words, what happened to the U.S. in the 1930’s was a severe attack of contagious laziness!

I can only say that, despite Sargent’s ingenuity, neither I nor, I expect most others at least of the nonMonetarist persuasion,. are quite ready yet. to turn over the field of economic fluctuations to the social psychologist!

As Prescott has pointed out, the USA in the Great Depression and France since the 1970s both had 30% drops in hours worked per adult. That is why Prescott refers to France’s economy as depressed. The reason for the depressed state of the French (and German) economies is taxes, according to Prescott:

Virtually all of the large differences between U.S. labour supply and those of Germany and France are due to differences in tax systems.

Europeans face higher tax rates than Americans, and European tax rates have risen significantly over the past several decades.

In the 1960s, the number of hours worked was about the same. Since then, the number of hours has stayed level in the United States, while it has declined substantially in Europe. Countries with high tax rates devote less time to market work, but more time to home activities, such as cooking and cleaning. The European services sector is much smaller than in the USA.

Time use studies find that lower hours of market work in Europe is entirely offset by higher hours of home production, implying that Europeans do not enjoy more leisure than Americans despite the widespread impression that they do.

Richard Rogerson, 2007 in “Taxation and market work: is Scandinavia an outlier?” found that how the government spends tax revenues when assessing the effects of tax rates on aggregate hours of market work:

  1. Different forms of government spending imply different elasticities of hours of work with regard to tax rates;
  2. While tax rates are highest in Scandinavia, hours worked in Scandinavia are significantly higher than they are in Continental Europe with differences in the form of government spending can potentially account for this pattern; and
  3. There is a much higher rate of government employment and greater expenditures on child and elderly care in Scandinavia.

Examining how tax revenue is spent is central to understanding labour supply effects:

  1. If higher taxes fund disability payments which may only be received when not in work, the effect on hours worked is greater relative to a lump-sum transfer; and
  2. If higher taxes subsidise day care for individuals who work, then the effect on hours of work will be less than under the lump-sum transfer case.

Others such as Blanchard attribute the much lower labour force participation in the EU since the 1970s to their greater preference for leisure in Europe. An increased preference for leisure is another name for voluntary unemployment.

The lower labour force participation in higher unemployment in Europe is voluntary because of the higher demand for leisure among Europeans.  According to Blanchard:

The main difference [between the continents] is that Europe has used some of the increase in productivity to increase leisure rather than income, while the U.S. has done the opposite.

An unusual left-right unity ticket emerged to explain the great depression in the 1930s and the depressed EU economies from the 1970s: the great vacation theory.

The economics of parenting | VOX, CEPR’s Policy Portal

across OECD economies parents in more unequal countries place more emphasis on hard work, and consider imagination and independence to be less important.

 

via The economics of parenting | VOX, CEPR’s Policy Portal.

Is welfare dependence optimal for whom – part 4: In-work tax credits and labour supply

In-work tax credits were introduced in many countries including New Zealand to encourage movement into employment by breadwinners. By linking a large payment with full-time and semi-full-time work, the rewards for working are increased for single parents and families. These in work tax credits combined child tax credit with an in work tax credit for the sole mother or couple.

These in-work benefits can phase-in when a minimum income level is reach such as with the Earned Income Tax Credit (EITC) in the USA, or a paid in full when a minimum number of hours are worked. The Working for Families in-work tax credit in New Zealand and the UK family tax credit are two examples where there is a large cash payment with no phasing-in:

  • Working for Families in New Zealand is paid if 30 hours are worked by New Zealand families or 20 hours are worked by sole parents; and
  • The British family tax credit was paid if 16 hours are worked, initially 24 hours per week.

Figure 1 shows the impact of the introduction of an in-work tax credit paid in full to families and sole parents if a minimum number of hours per week are worked by a family or sole parent. There is no phase-in region such as with the earned income tax credit (EITC) in the USA.

Figure 1: In work tax credits and labour supply

in-work tax credits and labour supply

The in-work tax credit phases-out after once the family’s income increases past an income threshold. This income threshold is usually linked to the number of children as well.

An in-work family tax credit linked to a high number of minimum number of hours worked provides an incentive for those not in work to increase their hours worked by a large amount and leave welfare, as is shown by arrow 1 in Figure 1.

For those already work, the income and substitution effect cut against each other and their net effect depend on the number of hours currently worked.

  • Those working a low number of hours, hours less per week than the minimum to qualify for the in-work tax-credit have an incentive to increase their hours to the minimum to qualify and leave welfare is shown by arrow 2 in Figure 1.
  • Arrows 3 and 4 in Figure 1 both represent reduction in hours worked.
  • Some workers can take-home more pay and work fewer hours per week or per year as shown by arrow 3.
  • Other high working hours worker can enjoy more leisure time at the expense of a slightly reduced take-home pay as shown by arrow 4.

The net labour supply effects of an in-work tax credit are therefore ambiguous because of these multiplicity of labour supply effects with some people working more another’s work in letters.

There will also be a bunching of hours worked at around the eligibility point for paying the in-work tax credit. The eligibility point is usually grouped around working a minimum of three or four days per week part or full-time that sum to 30 hours for families and 20 hours for sole parents.

Workers working less that the weekly working hour minimums will increase to the minimum to qualify for the family tax credit. Workers working more than the minimum required to qualify for the family tax credit might cut back to the working hours minimum because of the superior labour leisure trade-off. The number of people on welfare will fall because workers leave part and full benefit dependence to qualify for the in-work tax credit.

Whether labour supply on net actually increases or decreases depends on the relative numbers of individuals at different points on the budget constraint working full-time, not working and working part-time and on the magnitudes of their responses. Some will stay as they are working full-time, not working and working part-time.

To summarise, the static labour–leisure trade-off model of labour supply suggests that increases in either benefit abatement thresholds or a reduction in benefit abatement rates will increase the numbers entering the benefit and see none leave. No one will leave.

A hours worked per week based in-work tax credit will move people who are not working and working a low number of hours to work and into a higher number of work hours respectively, with bunching around the eligibility point. An in-work tax credit will also cause some to cut back their hours so the net labour supply effect is ambiguous.

The net fiscal cost of an in-work tax credit depends on the phase-in and phased out particulars of the tax credit programme and the increase in paid employment and the number of taxpaying workers as a result of the in-work tax credit. The Working for Families tax credits in New Zealand and the United Kingdom are famous for clustering of labour supply around the eligibility point for the in work tax credit.

single mum graphic

For example, in the UK, a lot of people used to work exactly 24 hours week. When the eligibility point was reduced to 16 per week, a new word had to be invented. This new word was mini-jobs to describe the large number of part-time workers in the UK who cut-back to exactly 16 hours per week. The family tax credit for workers is twice as generous in the UK as in New Zealand.

The blogs so far

part-one-the-labour-leisure-trade-off-and-the-rewards-for-working

part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes

part-3-abatement-free-income-thresholds-and-labour-supply

part-4-in-work-tax-credits-and-labour-supply

part-5-higher-abatement-rates-and-labour-supply

part-6-mandatory-work-requirements-and-labour-supply

part-7-the-role-of-tagging-in-welfare-benefits-system

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