PK and the literature

I always laugh when Paul Krugman urges others to read the literature. He’s a brilliant economist, but he’s not exactly the goto guy for literature reviews…

Today he says that Sumner and Avant should read the literature on macro vs micro labor supply elasticities. Well, ok, he says they should only read half of that literature. Over the last decade, Prescott has been doing a lot of work showing that differences in taxes explain differences in employment and hours worked between Europe and the US. I think his Nobel speech was about this.

The micro people threw fits though because their estimates of the response of labor supply to tax changes is much less extreme than Prescott’s finding suggest. They basically find labor supply curves are vertical. This would mean that taxes simply can’t have an effect on labor supply.

For a while, these guys had me convinced because, in general, micro/labor types do a much better job of identification and I trust their estimates more than I trust macro estimates. More recently, however, macro people ((A also vagualy remembering a paper that uses the PSID to estimate the two types of elasticities, but I can’t remember what it was.)) have been making the case that the “labor supply elasticity” estimated by the micro people is different from the “labor supply elasticity” the macro people estimate. The difference isn’t due to statistical methodology, we were just calling two different things the same thing.

Of course, its the macro elasticity that matters for tax policy, though. Prescott’s work (and not the paper that PK links to) is the place to go for understanding differences between Europe and the US. He says that difference is due to differences in tax and transfer policies.

UPDATE: AC found the PSID paper.

3 thoughts on “PK and the literature”

  1. Well, it’s a really bad idea to go to models where the extensive margin is handled by lotteries (i.e. full insurance among households). Sargent and Ljundqvist point out some counter-factual implications of that in their search-based critique of Prescott.

    I suspect there’s no way to deal sensibly with the labor market in a representative agent model. All sort of binding, household-level constraints are at play in full force.

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