Kevin T. Reilly

Testing Intertemporal Substitution, Implicit Contracts, and Hours Restriction Models of the Labor Market Using Micro Data

We present new tests of three theories of the labor market: intertemporal substitution, hours restrictions, and implicit contracts. The intertemporal substitution test we implement is an exclusion test robust to many specification errors and we consistently reject this model. We model hours restrictions as part of an endogenous switching model. We compare the implicit probit equation to an unrestricted probit equation for unemployment and reject the hours restriction model. For the implicit contracts model, we estimate nonseparable within-period labor-supply and consumption equations. We test a cross-equation restriction of the model and cannot reject the implicit contracts model. (JEL E30, J22, J60)

Increasing the Size of the ‘Country’: Regional Economic Integration and Foreign Direct Investment in a Globalized World Economy

Two contradictory trends characterized the world economy during the approach to the twenty-first century. First, the globalization of the economy, together with the successful conclusion of the Uruguay Round and the establishment of the World Trade Organization (WTO), brought about a steady decline in barriers to international business transactions. Second, however, as countries have lost their conventional powers to protect themselves from the outside world, they have grouped together, often on a pan-continental basis, into regional trading blocs. Regional economic integration, in the form of institutions such as the North American Free Trade Agreement (NAFTA), the European Union (EU) or the Asia-Pacific Economic Co-operation (APEC), represents the main way that remains accessible to countries in their attempt to maintain and promote their levels and shares of world investment, employment, income and growth.

Using Micro Data to Estimate the Intertemporal Substitution Elasticity for Labor Supply in an Implicit Contract Model

Economists have devoted substantial resources to estimating the intertemporal substitution elasticity for labor supply because this elasticity plays a crucial role in the real business cycle literature. Generally, the estimates of the elasticity have been too low to explain business cycles. Economists have responded by trying to modify real business cycle models to allow for smaller elasticities, but they have experienced mixed success at best. However, the standard intertemporal substitution model has not done well when tested, and if this model is incorrect, so will be the estimated labor supply elasticities based upon it. An equilibrium alternative to the standard intertemporal labor supply model is the implicit contract model. In this latter model firms and workers bargain over state-contingent contracts denominated in terms of consumption and hours of work. Further, the price of leisure is the marginal product of labor or the shadow wage, which differs from the observed wage. A number of studies have found that the data are compatible with an implicit contract model; in particular in Ham and Reilly (2002) we found that we could reject a separable (within period) implicit contract model but not a non-separable one. If an implicit contract model is appropriate, this is the context in which we should try to estimate the intertemporal labor supply elasticity. However this estimation is potentially quite difficult with micro data since the shadow wage (marginal product of labor) is unobserved. In this paper we first develop a procedure that allows one to estimate the intertemporal substitution elasticity in an implicit contract model from micro data. We then implement this procedure using the Panel Study of Income Dynamics (PSID) and the Consumer Expenditure Survey (CES). We obtain statistically significant elasticities of 0.9 with the PSID and 1.0 with the CES. The consistency of the estimate across the data sets is impressive given that we use different estimation approaches (micro data versus synthetic cohorts) and different consumption measures (food consumption versus total nondurable consumption) in the two data sets. These results are three times larger than existing estimates based on the standard intertemporal supply elasticity from this data set and thus offer more hope that equilibrium perspectives on the labor market are capable of tracking the data. Given that the implicit contract model is less likely to be rejected than the standard model in our work and other research, we believe that our approach should prove to be quite useful.

A Simple and Flexible Dynamic Approach to Foreign Direct Investment Growth: The Canada-United States Relationship in the Context of Free Trade

In the post-war period the world economy has seen the rise and expansion of regional trading blocs and regional economic integration.1 The prime example has been the evolution of the European Union since the early 1950s; also significant has been the creation of the Asia-Pacific Economic Cooperation Area in 1989, and development of the North American free trade area, dating also from 1989. This paper will focus on the Canada-United States relationship. While the intentions of the partners to a free trade agreement are clear in the case of trade, the effect on foreign direct investment (FDI) is ambiguous. The question this paper addresses is that of how the North American free trade agreements have affected US foreign investment behaviour in Canada.