Rethinking Labor Supply: Contract Theory and Unions

This paper suggests a new approach to the economics of labour supply. Conventional econometric studies conclude, with rare exceptions, that the response of men's hours to increases in wages is small and negative. Yet policy-makers in many countries have argued that incentive effects are large and have set low marginal tax rates accordingly. The evidence in this paper, from a sample of more than twenty-three thousand UK male employees, suggests that, for non-unionized labour markets, the labour supply wage elasticity is considerably large than the existing literature has suggested. The UK offers and unusually valuable test-bed for male labour supply modelling because it has a simple flat rate tax across the majority of the income distribution and offers two natural experiments that circumvent the simultaneity problems that have dogged the literature.