The previous two chapters have emphasized the purely “economic” determinants of labour supply—market wages, nonlabour income, and government programs. One of the more interesting other correlates of labour supply is age, and labour economists have spent considerable effort trying to explain why labour supply appears to vary systematically over an individual’s life cycle.
As a first step in exploring life-cycle labour supply, Figure 4.1 illus- trates the labour force participation rates by age groups for men and women. These age-participation profiles are shown for each of four census years: 1971, 1981, 1991, and 2001. The men’s profiles demon- strate the conventional inverted-U-shaped characteristic of life-cycle labour force patterns in most countries: participation increases sharply as men move into their twenties, peaks for ages 30 to 50, then declines as conventional retirement ages approach. While the profiles are very similar in each census year, notice that the participation rates of older men have declined significantly since 1971, suggesting that men are retiring earlier.
The women’s profiles are more complicated and provide an impor- tant example of the perils of inferring dynamic (i.e., life cycle) behaviour from cross-section data. Focus first on the 1971 profile. If interpreted as a stable representation of the pure effects of age on labour force par- ticipation, then we can use this profile to predict how many women will work as they age. One can imagine telling the following story: a typical woman increases her labour supply after high school into her mid-20s, reduces it sharply to raise a family, then gradually returns to work after age 35, until retirement.
LEARNING OBJECTIVES
LO1 c Explain why it is
misleading to compare behaviours and out - comes of different-aged individuals, concluding that the observed differences can be attributed to the pure effects of “age.”
LO2 c Distinguish
between the theoreti- cal effects a temporary increase in wage and a permanent increase in wage might have on an individual’s labour sup- ply decision.
LO3 c Paraphrase, for
non-specialists, factors highlighted by econo- mists when considering the question, where do babies come from?
LO4 c Describe Cana-
da’s three-tier public and private pension system.
LO5 c Explain using dia-
grams how changes to Canada’s public pension program can affect the age at which individuals choose to retire and how this can affect retirement incomes.
•
Do men’s and women’s labour supply patterns evolve similarly as they age?•
Is there a difference in the way indi- viduals respond to wage changes if the possibility that people make labour supply decisions with plan- ning horizons as long as their entire life is taken into account?•
What complexities are added to the labour supply framework once we try to model labour supply in each period of a lifetime?•
How might we incorporate the development of labour-saving household appliances into a model of female labour supply?•
How can economic analysis help in our understanding of fertility behav- iour, and the relationship between fertility and women’s labour supply?•
What factors determine the retire- ment age? In particular, what roles do public and private pension plans play in this decision?MAIN QUESTIONS
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Each panel shows the participation rates of men or women by age, for four years: 1971, 1981, 1991, and 2001. The men’s panel shows a strong inverted-U-shaped rela- tionship between age and participation, following the traditional life-cycle pat- tern. The women’s panel is more complicated because of the shift of the profiles over time, especially from 1971. The cross-section profiles (thin lines) do a poor job of predicting behaviour because of the confounding of age and cohort effects. The “actual” age effects are indicated by the thicker lines for three selected cohorts (born 1941–45, 1946–50, and 1956–60).
FIGURE 4.1 Age–Labour Force Participation Profiles
SOURCE: Based on data from Statistics Canada 1971, 1981, 1991, and 2001 Census of Population.
Pa rt ic ip at io n ra te Pa rt ic ip at io n ra te 0 20 40 60 80 100 2001 1991 1981 1971 75 70 65 60 55 50 45 40 35 30 25 20 Men Women 0 20 40 60 80 100 Born 1956–60 Born 1945–50 Born 1941–45 2001 1991 1981 1971 75 70 65 60 55 50 45 40 35 30 25 20
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!However, as can be seen in Figure 4.1 , predictions based on this story would be wrong. Consider 25-year-old women in 1971; that is, those born in 1946. They have a participation rate around 60 percent. If they followed the 1971 cross-section profile, we would predict a
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CHAPTER 4: Labour Supply over the Life Cycle
participation rate of about 40 percent for these women when they reached 35 years old (10 years later). By looking at the 1981 profile, however, we see that their participa- tion rate was much higher, at around 63 percent. Their participation rate is almost 20 percentage points higher than that for 35-year-olds in 1971. As can plainly be seen from this figure, more generally, the age-participation profile has not been stable for women. In 1971, 25-year-old women differ from 35-year-old women in more ways than their age: being 10 years younger, they were also born into a society with different economic and social conditions surrounding women’s work. Based on a single cross- section, it is difficult to disentangle the “pure” effect of age from a birth cohort effect.
The only way to reliably isolate the true effect of age is to track a specific cohort over time, across censuses. With the combined censuses, we observe the true age trajectory at 10-year intervals. For women born in 1956, we observe them at age 25 (in 1971), at age 35 (in 1981), and at age 45 (in 2001). Figure 4.1 shows the implied participation-age path for three different birth cohorts, estimated in this manner. For each cohort, the labour force participation rate generally increases with age (until retirement). Women’s profiles are thus shaped similarly to men’s, though with a slower entry into the labour force at younger ages. The figure also clearly shows that the participation rate of 30-year-olds increased dramatically between 1971 and 1991. There was less change between 1991 and 2001. To the extent that the cross-section pro- files stabilize, we can also see that the smaller cohort effects lead to a closer correspondence between the cross-section and actual age profiles, as demonstrated by the most recent birth cohort (born 1956–60).
The focus of this chapter is on reviewing how labour economists explain the pure age effects, rather than on why these effects may be changing over time. Nevertheless, there have been a number of important studies that try to document and explain this shift in participa- tion profiles for women. Beaudry and Lemieux (1999) analyze the shifting profiles for Cana- dian women, and the slowdown in the increase in women’s participation in the 1990s. Using methods similar to those sketched in connection with Figure 4.1 , and the Worked Example, they isolate pure cohort effects from age effects. While it is more difficult, they are also able to net out macroeconomic business-cycle (or time) effects that also cause the observations from different years to bounce around confounding our ability to observe “long-run” relationships in “short-run” data. Their results suggest that most of the changes in participation reflected in Figures 4.1 (and 2.2) are driven by (permanent) cohort effects. As for explaining these shifts, most studies, such as Claudia Goldin’s 1990 book examining changes in women’s par- ticipation over the entire century, or Dooley’s 1994 paper looking at mothers in Canada, find that the increase in participation rates cannot be explained by changes in economic variables alone; that is, by changing incentives for women to work. These results suggest that changing “preferences” remain an important explanation, and the nature of these changes (e.g., in the attitudes toward married women working) remains an important area of research for both economists and sociologists.
Labour economists seek to assess whether the observed labour force patterns over the life cycle can be explained by changes in the economic environment in a way predicted by the- ory. For example, does the inverted-U shape of participation derive from a similarly shaped wage profile, mediated by an upward-sloping labour supply function? In this chapter, we will examine different approaches to this problem. In addition, there are (at least) three important life-cycle-related phenomena that merit separate attention. The first is the school-work deci- sion: when and whether to acquire education, and the commensurate timing of work. This is a major topic and the subject of the chapters on human capital. The second is the fertility decision of women. We have already discussed the theoretical apparatus used to analyze the impact of children on women’s labour supply, but in this chapter we explore the economic aspects of the decision to have children in the first place. The third is the decision to retire, or “permanently” withdraw from the labour force. Not only is this an interesting application of labour supply theory, but it is also an increasingly important public policy issue.
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WORKED EXAMPLE