Wednesday, January 23, 2013

Reconciling macro and micro estimate of the Frisch labor supply elasticity

If you manage to get a labor economist and a macroeconomist to talk to each other, invariably the conversation will turn to the fact that macroeconomists use a Frisch elasticity of labor supply that is much too high to what microeconomic labor studies seem to reveal. And both will absolutely stand their ground and treat the other with disdain. This mutual frustration has gone for a long time as it has been extremely difficult to reconcile micro and macro estimates. One solution to this is to accept that they are going to be different, even when estimated wit the same dataset (see previous post). But that does not seem to have settled the debate.

William Peterman points out that microeconomic estimates are usually drawn from a sample of white married male heads of household. These are probably the least flexible in the labor force, so you should not be surprised that their working hours are little affected by wage changes. It is a different story for females and dependents, and once you include them in the sample, voilà you have the typical macro estimate of the elasticity, especially when the extensive margin (work or not work) is taken account of. In other words, macro and micro labor people are not talking about the same elasticity, so no wonder they are not getting the same estimates.


rené böheim said... find that micro estimates are consistent with macro evidence on the steady-state (Hicksian) elasticities relevant for cross-country comparisons. However, micro estimates of extensive-margin elasticities are an order of magnitude smaller than the values needed to explain business cycle fluctuations in aggregate hours. Hence, indivisible labor supply does not explain the large gap between micro and macro estimates of intertemporal substitution (Frisch) elasticities. Our synthesis of the micro evidence points to Hicksian elasticities of 0.3 on the intensive and 0.25 on the extensive margin and Frisch elasticities of 0.5 on the intensive and 0.25 on the extensive margin. (Their abstract)

Anonymous said...

Peterman addresses the difference between his and their estimates. They use the participation elasticity as a proxy for the extensive margin elasticity. However, Peterman shows that this may be a biased estimate.

rené böheim said...

Yes, you are correct, however, the bias may result from a change in the meannumber of hours supplied. If there is litlle or no change on average, then I'd not worry (too) much.