Transcript Issues in the Comparison of Welfare Between Europe and the

Issues in the Comparison of
Welfare Between Europe
and the United States
Robert J. Gordon
NAPW IV Conference,
NYU Stern School, New York City
Keynote Speech, June 28, 2006
What are the Substantive Issues?
“Why is Europe so Productive yet so Poor?”
 If Y/H caught up but Y/N languished, then the
superficial Answer is H/N has been falling
 Why?

– Blanchard (JEP, p. 4): “The main difference is that
Europe has used some of the increase in productivity
to increase leisure rather than income, while the
United States has done the opposite.”

Blanchard will be the straw man in this
discussion of more subtle interpretations
2
Outline of the Paper

Interpretation of falling relative hours per capita
in Europe vs. U. S.
– Major hypothesis: only a small portion of falling
relative hours per capita represents welfare value of
leisure
– Addressing the current debates





Blanchard – it’s all the taste for leisure in Europe
Prescott – taxes explain everything
Ljungvist-Sargent – welfare state is more important
Alesina – Politics and unions
An Independent Issue: Is GDP in US
overstated?
3
An Opposing View

By definition the decline in Europe’s Y/N
related to Y/H can be divided into:
– Decline in relative H/E (35% 1960-95)
– Decline in relative E/N (65% 1960-95)

Voluntary Leisure?
– Some of decline in H/E is not voluntary
– Most of decline in E/N is not voluntary
4
Part #1:
What are the Data Issues?
How to Compare Europe GDP vs. US GDP
 Thanks to Peter Neary AER Dec 2004:

– Geary vs. EKS vs. “QUAIDS”

Alternative methods of converting Ypc to
international PPP
– Maddison and PWT use Geary-Khamis
– OECD and Eurostat use EKS (Eltetö, Köves, and
Szulc), a multilateral extension of Fisher “ideal”
– Groningen web site gives both
5
An Operational Procedure

My calculations from Neary for EU-15 / US 1980
– Neary preferred QUAIDS = 74.3
– GK 71.4, EKS 77.5
– Average Groningen GK and EKS = 74.4
Hence all charts from here on use average of GK
& EKS
 This applies only to GDP, not to population,
hours, employment, labor force

6
Other Data Issues
Hedonic Price Indexes: Data
Noncomparable?
 Studies for Germany show difference in
AAGR productivity of ~0.2
 Some EU countries use hedonics for
computers so overall EU difference would
be less

– Groningen data use US price computer price
deflators for all European countries
7
A Preview of ALL THESE SLIDES
Slides of Europe vs. U. S., 1820-2004 for Y/N,
1870-2004 for Y/H
 Maddison through 1950, ratio-linked to
Groningen 1950+, average GK and EKS

– Maddison piecewise loglinear trends. Years for Y/N:
1820, 1870, 1913, 1923, 1929, 1941, 1950
– Y/H 1870, 1913, 1929, 1938, 1950
Each slide, a wide angle back to the start, then a
“close-up” 1960-2004
 Ratios, then Ratios of Ratios

8
The Broad Sweep of 2 Centuries:
Income per Capita
100000
United States
10000
Europe - 15
1000
1820
1830
1840
1850
1860
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990 9 2000
Since 1960: Europe Fails
to Converge and then Falls Behind
36000
31000
26000
United States
21000
Europe - 15
16000
11000
6000
1000
1960
1965
1970
1975
1980
1985
1990
1995
2000
10
Productivity since 1870:
Almost Catching Up is Not Enough
100
United States
10
Europe - 15
1
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
112000
Productivity Post-1960:
The Ratio Reaches 96.9% in 1995
45
40
35
United States
30
Europe - 15
25
20
15
10
5
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
12
The Europe / US Ratios
Are Much More Dramatic
120
100
Output per capita
Output per hour
80
60
40
20
0
1820
1830
1840
1850
1860
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
199013 2000
The Ratios Again:
A Post-1960 Close-up
110
100
Output per hour
90
80
Output per capita
70
60
50
40
1960
1965
1970
1975
1980
1985
1990
1995
2000
14
Ratios of Ratios:
The Real Clue to What is Going On
130
120
Employee to population ratio
110
100
Hours per employee
90
80
Output per capita to
output per hour ratio
70
60
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
152000
Ratios of Ratios:
The Post-1960 Close-up
130
120
110
Employee to population ratio
100
Hours per employee
90
80
Output per capita to
output per hour ratio
70
60
1960
1965
1970
1975
1980
1985
1990
1995
2000
16
What the Recent
Macro Annual Debate has Missed
The EU/US Ratio for EmploymentPopulation turned around in 1995
 Why?

– A reversal of labor market regulations?
– A reversal of product market regulations?
– A reversal of labor taxes?

But the decline in hours/employee did not
turn around
17
Hours per Employee Declined
in Tandem until 1970, then
diverged
3500
3000
United States
Europe - 15
2500
2000
1500
1000
500
0
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
182000
A Close-up of Hours per Employee
after 1960
2200
2100
2000
United States
1900
Europe - 15
1800
1700
1600
1500
1400
1960
1965
1970
1975
1980
1985
1990
1995
2000
19
Employment per Capita
back to 1870
55%
50%
45%
Europe - 15
40%
United States
35%
30%
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
202000
Employment per Capita after 1960:
U.S. Women and Teens
Marched Off to Work 1965-1990
55%
50%
United States
45%
40%
Europe - 15
35%
30%
1960
1965
1970
1975
1980
1985
1990
1995
2000
21
Summary of Turnaround in
E/N vs. H/E
Table 1
Levels and Growth Rates of Three Ratios of Europe to the United States, 1960-2004, percent
Hours
Hours
Employees
per Capita
per Employee
per Capita
1960
119.8
102.4
115.9
1970
102.4
97.4
105.6
1995
73.6
87.1
85.7
2004
77.2
85.4
91.7
1960-70
-1.6
-0.5
-0.9
1970-95
-1.3
-0.4
0.5
-0.2
Annual
Growth Rates
1995-2004
22
-0.8
0.8
An Outline of Issues for Discussion
Europe’s failure to converge is not just a matter
of voluntary vacations
 Much more of the change 1960-95 was the
decline in employment per capita
 Even lower hours are not entirely voluntary

– “If the French really wanted to work only 35 hours,
why do they need the hours police?”

Alesina:
 Short hours are a victory for unions and parliamentary
politics, not for free choice
 So is early retirement, a major source of falling E/N
23
Textbook Labor Economics
7
6
High-Cost Labor
Supply Curve
Labor Demand
Curve
5
Real Wage
4
(W/P)0
A
3
Low-Cost
Labor
Supply Curve
(W/P)1
B
2
1
0
Downward shift in labor
supply curve reduces real
wage and productivity
-1
-2
1
2
3
4
5
N0
6
Labor Input
7
N1
8
9
10
11
24
Welfare Valuation of Leisure
Work time is chosen to equate marginal utility of
leisure to after-tax wage
 Diminishing marginal utility of leisure

– Infra-marginal leisure valued > wage
– Extra-marginal leisure valued < wage

Back-of-envelope.
– Value weekday and weekend leisure of both workers
and retired = 4/3 after-tax wage
– Value hours switched from work to retirement = 2/3
after-tax wage
25
What Matters for Welfare is Y/N
+ Differential Leisure, not Y/H

Europeans have “bought” their high
productivity ratio with every conceivable
way of making labor expensive
– High marginal tax rates (payroll and income
taxes)
– Firing restrictions
– Early retirement (55! 58!) with pensions paid
for by working people
– Lack of encouragement of market involvement
by teens and youth
26
The Decline in Europe’s E/N
Matters more than H/E
First, which age groups are suffering from
higher unemployment in Europe?
 Second, which age groups experience
lower labor force participation in Europe?
 Third, how does it come together in the
distribution of low E/N by age group?
 Note: These graphs are for total
population by age and blur male/female
differences.

27
Unemployment by Age:
EU vs. US
25
20
15
10
5
0
15-19
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60-64
65-69
28
70-74
Labor-force Participation
by Age
90
80
70
60
50
40
30
20
10
0
15-19
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60-64
65-69
29
70-74
Putting it Together:
Europe vs. US E/N by Age Group
90
80
70
60
50
40
30
20
10
0
15-19
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60-64
65-69
30
70-74
Weighting the Age Groups:
Older in Europe
9
8
7
6
5
4
3
2
1
0
<15
15-19
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-59
60-64
65-69
70-74
3175-79
Decomposing the EU/US Difference
in the E/N Ratio
age distribution
unemployment
LFPR
E/N ratio
EU
EU
EU
87.14
US
EU
EU
86.19
EU
US
EU
91.23
EU
EU
US
97.11
US
US
EU
90.77
EU
US
US
102.1
32
Big Issues: Low LFPR of Old
and low E/N of Young
About the old, why have European statesupported pension plans encouraged early
retirement (age 58 in France and NL)?
 Alesina (2006) cites this as a prime
example of the work-sharing philosophy of
unions and European leftist parties
 Unions and leftists also responsible for
long vacations and short work weeks, esp.
in France

33
Brief Summary of the
Recent Prescott Debate


Prescott says it’s all higher taxes in Europe
This is consistent with
– Firms cutting jobs
– Employees choosing untaxed leisure
– So decline in both H/E and E/N are involved

Problems:
– Alesina, labor supply elasticities don’t match
 The labor-supply elasticity for adult men is zero
 The elasticity for females and teenagers is high, but they are
only half of the story
 Thus Prescott can explain only half of labor withdrawal
– Me, not consistent with age distribution story
34
Ljungqvist-Sargent’s skepticism
on the “national family”
Prescott assumes national family, voluntary
redistribution to those who withdraw labor
because of high taxes
 In reality most of those who withdraw labor
supply because of high taxes are not supported
by voluntary family transfers
 Are supported by government transfer payments
that “strain social insurance systems”;
“government expenditures were poor substitutes
for private consumption”

35
Alesina on Unions
and Regulation
Contrast between U. S. and EU
 U. S. union penetration peaked in late 30s,
1940s, declined after 1950s
 Europe peaked in late 1970s, early 1980s
 No disagreement about what unions do to
the labor supply and demand diagrams

– Unions push the economy northwest
36
Channels of European
Union Influence (Alesina)
Unions keep wages artificially high
 Unions may pursue a political agenda to
reduce work hours
 Unions impede the reallocation of labor in
response to sectoral shocks


Neither Alesina nor critics notice
turnaround in Europe’s E/N after 1995
37
Alesina Examples of Union Power
Reducing hours per week and raising
wage per hour
 Examples of defending “the welfare state
and public pension systems”
 Pushing Early Retirement

– In General
– As a solution to plant closings
38
Critique of Modern Macro
Interpretations
About Alesina, timing is wrong. Union
density increased 1960-80, but then fell to
1995 to about the same level as 1960
 This argument from Rogerson (2006)
ignores inertia in political process
 None of theories have provided an
explanation of the EU post-1995
turnaround in E/N

39
A Broader View:
The Welfare Cost of Higher
Unemployment
The distinction between marginal hours of
leisure (40 work, 80 leisure) vs.
inframarginal hours (20 work, 100 leisure)
 Gordon (1973) distinction temporary vs.
permanent increase in U

– Output loss 2.7 vs. 2.3 for temporary case
– Output loss 0.7 for permanent case
40
The Welfare Effect of Early
Retirement: Back-of-Envelope
Baseline: work age 20-65, retire 65-84
 No saving, investment
 30% tax finances pay-as-you-go pensions with
balanced govt budget

– Tax finances equality of consumption in retirement to
consumption during work years

Alternative retirement age at 55 requires tax
increase to 45.6%, 25.1% decline in
consumption during work years and retirement
41
Welfare calculation
With 55 retirement age, after-tax wage is
25% less
 Extra hours switched from work to
retirement leisure are low-valued (2/3)
 Total welfare = market consumption plus
total value of leisure
 Market consumption declines 25.1
percent, welfare declines 22.6 percent,
ratio 90% (i.e., leisure offsets 10%)

42
Time Allocation from
Freeman-Schettkat
Freeman average males & females,
workday
 M=market, H=home production,
L=leisure, P=personal time (sleep)
 I set P>9.0 as Leisure
M H
L
P
Employed
8.0 2.5 4.5 9
Unemployed 1.0 4.5 9.5 9

43
What’s Wrong with
European Youth?
Youth enter late into Market Employment
 If we are assessing extra European “leisure”,
how much if any credit do we give to youth?

– Disconnected from the market economy
– American youth are expected to work

Link with government support of higher
education: tuition grants in Europe vs. peerreviewed research grants in US
– Plus state university subsidies
44
Turn the Tables on the U. S.:
The “Disconnect” between Welfare
and PPP-Adjusted GDP

GDP Exaggerates U. S. GDP per Capita
– Extreme climate, lots of air conditioning, low
petrol prices, huge excess energy use
– U. S. urban sprawl: energy use, congestion
– Crime, 2 million in prison
– Insecurity, lack of employment protection,
lack of citizen’s right to medical care

How much is this worth?
45
A Shrinking Explanation:
Declining Btu / GDP
400
25
350
20
Btu per capita
300
15
Btu/GDP
250
200
1940
10
1950
1960
1970
1980
1990
2000
5
2010
46
The EU-US Difference
is only 2% of GDP
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
1980
1985
1990
1995
2000
47
Other Additions or Subtractions
from Europe’s Welfare

Urban Congestion?
– London vs. NY?
– Paris vs. Chicago?
– Time spent in London underground vs. in a
Chicago automobile?
Prisons, perhaps 1% of GDP
 Undeniable U. S. superiority: housing

– People value interior square feet (2X in US)
– People value exterior land (4X in US)
48
The Intangible and
Unknowable
The value of security in Europe
 Prescott counts only the substitution
effects of higher labor taxes
 Europeans get full value back per tax
dollar in valued government services

– U comp, maternity leave, pensions, severance
pay
49
Putting it Together for 2004
EU/US Y/N = 68.8
 EU/US Y/H = 89.2
 Raise Europe:

–
–
–
–
67% of H/E difference (11.8) is leisure = 7.9
10% of E/N difference (8.6) = 0.9
Half of Energy use difference = 1.0
Prisons and other = 1.0
Europe’s welfare vs. U. S. = 79.6
 Understated because of security vs. insecurity,
but who knows how much?

50
Table 2
Summary of Adjustments to the Europe-to-U.S. Ratio of Per-capita Income, 2004
Market PPP Ratio of Y per Capita
Europe-to-U. S.
Adjustment to
Adjustment to
Ratio of Real GDP per Capita
Leisure Component of Hours
GDP
68.8
Add: 2/3 of Difference
in Hours per Employee (11.8)
7.9
Add: 1/10 of Difference
in Employment per Capita (8.6)
0.9
Add: Half of Energy Use Difference
1.0
Add: Prisons and Other
1.0
Sum of Market PPP Ratio and
above Additions
79.6
Market PPP Ratio of Y per Hour
89.2
Percent Prody Gap Explained
52.9
Percent Total Gap Explained
30.8
51