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Dynamic labor supply adjustment with bias correction

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Abstract

I estimate a dynamic fixed effects hours equation for prime-age men with bias correction. Studies using household data typically find a weak response in hours of work to changes in the wage. This paper finds that rather than indicating a small elasticity of intertemporal substitution, the weak dependence of hours on wages is the result of delayed adjustment. The coefficient on the lagged dependent variable is found to be between 0.31 and 0.33, which suggests that it takes 1.5 years for an individual in the sample to adjust hours of work to a change in the wage or other preference variables, an important consideration in policy evaluation. Failure to correct for incidental parameter bias leads to underestimating this effect by more than 15%. Time-varying endogeneity of the wage is handled using a control function approach.

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Notes

  1. See Blundell and MaCurdy (1999) for an overview.

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Acknowledgments

I thank Frank Vella for invaluable advice and comments on this paper. I am also grateful to an anonymous referee for very helpful comments.

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  1. Department of Economics, Oregon State University, 303 Ballard Hall, Corvallis, OR, 97331, USA

    Elizabeth Schroeder

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  1. Elizabeth Schroeder
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Correspondence to Elizabeth Schroeder.

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Schroeder, E. Dynamic labor supply adjustment with bias correction. Empir Econ 51, 1623–1640 (2016). https://doi.org/10.1007/s00181-015-1044-6

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  • DOI: https://doi.org/10.1007/s00181-015-1044-6

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