European Vacation: Why Americans Work More Than Europeans | Federal Reserve Bank of Minneapolis (2024)

It's no secret that Europeans work less than Americansdo. Every Labor Day the media tell us that Europeans have just enjoyedweeks of summer vacation while Americans have been toiling away. Thesestories often depict Americans as hard-working drones who revere materialpossessions above all else. Europeans meanwhile bask in the good lifeof long lunches and months at the beach.

There is some truth to the portrayal, at least in terms of hours worked.The International Labor Organization reports that the average Americanworked 1,815 hours in 2002, well above the comparable figures forFrance (1,545) and Germany (1,444), for example. (The average SouthKorean, on the other hand, worked over 2,400 hours.)

But if it's widely acknowledged that Americans work more hours thanEuropeans, it remains a puzzle quite why there's such a large difference.With similar economies and social structures—at least relativeto the rest of the world—it would seem that labor patterns shouldalso be alike. Social scientists have been hard-pressed to explainthe disparity.

Most accounts focus on cultural explanations. The most popular isthe notion that Europeans have a fuller appreciation of la dolcevita—the sweet life—the Italian version of the ideathat life is to be enjoyed, not endured. Work is a means to an end,not an end in itself.

The idea of cultural and religious influences on economic activityisn't new. German sociologist Max Weber wrote The Protestant Ethicand the Spirit of Capitalism nearly a century ago, attributingthe rise of capitalist economies to the "Protestant work ethic."It was an immensely persuasive theory in its time, and derivativeexplanations have held great sway ever since.

"Why do Europeans and Americans differ so much in their attitudetoward work and leisure? I can think of two reasons," opinesa recent Time magazine essay. "Broadly speaking, Americansvalue stuff—SUVs, 7,000-sq.-ft. houses—more than theyvalue time, while for Europeans it's the opposite. Second, ... inthe puritanical version of Christianity that has always appealed toAmericans, religion comes packaged with the stern message that hardwork is good for the soul. Modern Europe has avoided so melancholya lesson."

"It all comes down to what people feel is important and howthey feel about their lives," argues a September 2003 U.S.News & World Report editorial. "We value more moneyand more stuff; they value more leisure time. ... We are proud ofbeing busy—it is a virtue; being idle is perceived as a vice."

Economic explanations

Economists have always been suspect of such cultural explanations.Standard economic theory assumes that people's preferences are, onaverage, hom*ogeneous, and that choices depend largely on economicfactors. Still, while economists agree that dollars and cents liebehind the work pattern differential, there is little harmony amongthem as to the right economic explanation.

Some economists say work regulations keep Europeans from working longerhours and point favorably to recent European reforms on vacation time.Others argue that greater inequality in the United States motivatesworkers to try harder to get ahead. Most of these explanations comefrom the perspective of labor economics and its core belief that socialstructures and institutions such as unions are the major determinantsof labor patterns.

But in a recent series of papers and lectures, Edward C. Prescott,senior monetary adviser to the Minneapolis Fed and economist at ArizonaState University, looks at the labor supply question through the prismof the growth model—a different perspective altogether—andprovides a convincing and remarkably straightforward explanation forthe dramatic differences in hours worked. It is an explanation thathas far-reaching implications for policymakers—and for anyoneelse who's ever received a paycheck.

According to Prescott, the reason for these large differences in laborsupply is not culture. "French, Japanese, and U.S. workers allhave similar preferences," he writes. "The French arenot better at enjoying leisure. The Japanese are not compulsive savers."The reason for the wide range in working hours is, in a word, taxes.Europeans supply less labor because there's a much larger wedge inmost European countries between what a worker is paid and what thatworker actually gets to keep after taxes are taken out. This tax wedge,argues Prescott, distorts the trade-off people make between consumptionand leisure by making consumption more expensive. And since peoplework, ultimately, to earn money to pay for consumption goods, they'llsupply less labor if consumption goods become relatively more expensive.The cheaper alternative: leisure. Hello, Riviera.

If the concept seems straightforward, its evolution was anything but.Like most ideas that seem obvious in retrospect, the awareness thattaxes distort labor markets dramatically and account for major internationaldifferences in work patterns came about indirectly and as a revelationto those who happened upon it.

The discovery

Prescott's discovery about the role of taxes in labor supply variationbegan, simply enough, in his classroom at the University of Minnesota,where he taught from 1980 to 2003. "I was making up exercisesfor my students," he recalled in a recent interview. "Isaid, 'use this nice little growth model.'"

The "nice little model" he presented to his students isthe workhorse of modern macroeconomics; it says, mathematically, thata nation's total output (or gross domestic product, GDP) is dependenton three sources: labor, capital and the efficiency (or productivity)with which it merges them to create economic value. The other keypart of this standard theory is, in the jargon of economics, a utilityfunction: a formula representing the notion that households try tomaximize their happiness by finding the best possible combinationof leisure and consumption, given their resources.

Prescott wanted his students to become familiar with this model bylooking at how it performed in different nations over time, and howkey variables—capital endowments, productivity, labor supply—couldaccount for differences among nations in per capita GDP. "Iwanted to try to get across the basic ideas and the importance ofproductivity," said Prescott. "And then I thought, let'sput a few taxes in."

The intuition was far more significant than Prescott suspected, butthat became clear only after looking at the relative contributionsof capital, productivity and labor. The data, compiled by the UnitedNations and the Organization for Economic Cooperation and Development,showed that in the mid-1990s among developed countries—the UnitedStates, much of Europe and Japan—relative levels of capitaldiffer little and explain just a small portion of the variation inper capita GDP (see adjacent table). "The capital factor isnot an important factor in accounting for differences in incomes acrossthe OECD countries," writes Prescott in his2002 Richard T. Ely Lecture to the American Economic Association. "[It]contributes at most 8 percent to the differences in income betweenany of these countries."

Productivity, on the other hand, is very important, at least forsome national differences. Japan and the United States, for example,have similar levels of labor and capital, but per capita GDP in Japanis far below that in the United States because its productivity isless than three-quarters that of the United States.

But what of European countries like France, Italy and Germany? Whyare their levels of per capita GDP so much lower? All these nationshave capital endowments comparable to the United States. Their productivitylevels also are similar to U.S. rates, or in the case of France, evenhigher. The data suggest that the differences in wealth are due almostexclusively to the markedly lower number of hours worked in theseEuropean countries. Germany, for instance, had a slightly higher capitalendowment than the United States and an equal level of productivity,but just 74 percent of the U.S. per capita GDP. The evident reason:Its workers supplied just over 19 hours of labor per week comparedto nearly 26 hours a week per American worker.

While many believe that cultural differences lead to fewer hours workedin Europe than in the United States, Prescott doubts it. After all,data from the early 1970s show that the French actually worked morehours per week than did Americans at that time. Has French culturechanged radically over the last two decades? Probably not: They stilllike good wine, aged cheese and, inexplicably, Jerry Lewis. Prescott'shunch was that differences in marginal tax rates might explain thedifferences in labor supplied and thus account for differences inper capita GDP.

Enter the tax wedge

"What is important is the price of consumption relative toleisure," Prescott writes in the lecture he gave in April 2003as he accepted Northwestern University's prestigious Erwin Plein NemmersPrize in Economics. "And it is determined by the consumptiontax rate and the labor income tax rate." (See the lecture, "Why Do Americans Work So Much More Than Europeans?")

By introducing these taxes into the growth model, and making standardmicroeconomic assumptions, Prescott derived what he calls "thekey equilibrium relation."1 It's a mathematical formula for labor supply that says workers willsupply labor dependent on, among other things, their preference forconsumption now over consumption later (spend or save?), their preferencefor leisure relative to consumption (play or work?) and the effectivetax rate. Holding the first two variables fixed and looking empiricallyat different national tax rates enables Prescott to see if tax differencescan account, fully or partially, for variations in labor hours supplied.

Estimating the effective tax rates in these countries was, in itself,a major accounting exercise. Consumption taxes include value-addedtaxes, sales taxes, excise taxes and property taxes. Labor is subjectto both income taxes and Social Security taxes. For each nation underconsideration, Prescott and his students crunched the numbers, determineda tax rate, plugged it into the formula along with fixed estimatesof the other variables, and derived predictions of labor hours suppliedper week per worker.

How good were the predictions? Dead-on for Germany and the UnitedKingdom, a bit low for Canada and the United States, and a bit highfor the other countries (see table below). Given measurement inaccuracies,the rough nature of the tax-rate estimates and the difficulty of internationalcomparisons, writes Prescott, the model's predictions were "surprisinglyclose to the actual."

Here, notes Prescott, "the important observation is that thelow labor supplies in Germany, France and Italy are due to high taxrates. In these countries if someone works more and produces 100 additionaleuros of output, that individual gets to consume only 40 euros ofadditional consumption and pays directly or indirectly 60 euros intaxes." Put in such stark terms, it seems obvious that manyEuropeans might opt to work less, while Americans and Japanese, taxedmore lightly, would be keen to put in extra hours.

Confirmation and implications

Prescott found further confirmation for his hypothesis when he lookedat tax rates and labor supply in the early 1970s (see table below).While his model's predictions of labor hours supplied diverge fromthe actual in several cases—Italy and Japan, in particular—Prescottobserves that "when European and U.S. tax rates were comparable,European and U.S. labor supplies were roughly equal."

As for the outliers, Italy and Japan, Prescott suggests that otherfactors may be significant. In Italy, cartels may have played a rolein depressing labor supply below its predicted value. In Japan, significantmeasurement errors in actual hours worked could account for the overlyhigh prediction by the model.

And what seems another anomaly is very likely an indirect confirmationof the importance of marginal tax rates on labor supply, accordingto Prescott. In the United States, actual hours worked per personincreased by 10 percent from the 1970s to the 1990s, though the marginaltax rate remained at 40 percent. Prescott argues that U.S. tax reformsin the 1980s changed the effective marginal tax faced by married couples—droppingthe rate in half for the second earner's income—even thoughit remained nominally at 40 percent.

"In the 1993-96 [period]," he writes, "the marginalincome tax on the labor income associated with switching between aone-earner and a two-earner household is only 20 percent, not 40 percent."The issue warrants more attention, he says, and indeed, his colleaguesLarry Jones, Rodolfo Manuelli and Ellen McGrattan have recently releaseda paper on this exact question. (See "Wivesat Work.")

On the whole, Prescott states, the results show that "peopleare remarkably similar across countries" and not only for theserelatively prosperous and hom*ogeneous nations, but for Chile, Mexicoand Argentina, as well, where other economists have found similarrelationships. "Apparently, idiosyncratic preference differencesaverage out and result in the [representative] household having almostidentical preferences across countries."

The policy implications are enormous for high-tax countries. If Francewere to lower its effective tax rate from 60 percent to 40 percent,estimates Prescott, its people would work more (taking 6.6 percentless leisure) and—remember their high productivity?—wouldgenerate considerably more output. Tax revenues wouldn't diminish,because the 40 percent rate would be levied on a higher base. Andoverall French "welfare gains," as economists put it,would increase nearly 20 percent. In the United States, reducing marginaltax rates would have a more modest impact, according to the model:A 10 percent rate reduction would produce a 7 percent welfare gain.But even in the United States, Prescott's findings have huge implicationsfor the viability of the Social Security system. (See "Shrinking a deadweight loss.")

Foreign affairs

In recent months, Prescott has traveled widely, presenting his findingsnot only to American audiences but to economists and policymakersin London, Berlin, Toulouse, Tokyo and elsewhere overseas. And infact, says Prescott, Europeans tend to be more receptive than Americans."The economists there understand that there is a problem,"he said after returning from France in mid-September. "I gotsome excellent suggestions when I presented the paper, the best sofar." But at all venues, he observes, the common denominatoris surprise.

Prescott is the first to admit that he, too, thought the results werestartling, unexpected. "I find it remarkable that virtuallyall of the large difference in labor supply between France and theUnited States is due to differences in tax systems," he writesin his Ely lecture. "I expected institutional constraints onthe operation of labor markets and the nature of the unemploymentbenefit system to be more important."

Moreover, he concedes that cultural explanations might carry the dayin a few settings. "Scandinavians seem to be a little bit different,"he said recently, referring to research by Richard Rogerson, an economistat Arizona State University. "My theory is when one of thoseSwedes looks at you when you're not working, it's pretty intimidating."More seriously, he allows that in small, hom*ogeneous cultures, socialpressures can be quite strong.

But even in large, heterogeneous nations, tax wedges don't alwaystell the whole story, according to Prescott. "Taxes are notthe only reason that the labor factors differ," says Prescott'sEly lecture.

Unemployment benefits and housing subsidies—not taxes—distortedlabor mobility in the United Kingdom between the first and secondWorld Wars, contributing significantly to that country's interwardepression. New Deal policies supporting cartels in America's heavyindustries distorted wages and employment in the last half of the1930s, contributing to the depth and duration of the Great Depressionin the United States. Similarly, cartels in 1970s Italy may have suppressedemployment there. Prescott relies on work by University of California,Los Angeles economists Harold Cole and Lee Ohanian in making theseconjectures.

Still, while taxes aren't the all-powerful explanatory factor forall nations and eras, Prescott contends that in major developed countriesin the time period under consideration, the labor supply impact oftax wedges is a powerful and undeniable fact.

Other academics

As befits the work of any prominent scholar, Prescott's theory hasattracted close academic scrutiny—beyond the initial reactionof surprise—from both adherents and critics. In one recent paper,Peter Lindert, an economist at the University of California, Davis,refers to Prescott's study as dependent upon "a theoreticalmodel heavily laden with assumptions. It is educated, intelligent,plausible fiction—but fiction nonetheless."

On the other hand (as Lindert points out) Prescott's model and findingsare cited quite favorably by Nobel Laureate Robert Lucas in his 2003presidential address to the American Economic Association.

Lindert calls for empirical tests. Steven Davis at the Universityof Chicago Graduate School of Business and Magnus Henrekson of theStockholm School of Economics oblige with a careful econometric analysisof the impact of labor income and consumption taxes on employmentand work activity. In their study of rich countries in the mid-1990s,they find that a 12.8 percentage point difference in tax rates isassociated with 122 fewer market work hours per adult per year andnearly a 5 percentage point decrease in employment—populationratios—an indirect affirmation of Prescott's theory.

A very different perspective was presented earlier this year in aseries of lectures by British economist Richard Layard, co-directorof the Centre for Economic Performance at the London School of Economics.Layard takes issue with GDP itself as a satisfactory measure of humanwelfare—or utility, as Jeremy Bentham and subsequent economistshave termed it—noting that "happiness has not increased,despite huge increases in living standards."

To summarize a lengthy argument, Layard's idea is that a tax wedgeon labor income could actually increase utility by decreasing a sortof pollution: overwork brought on by the inherent human desire todo better than our peers, regardless of our absolute level of income.Keeping up with the Joneses, in other words, leads to overwork, illhealth and unhappiness—rivalry distorts the leisure/labor decision.Appropriate public policy should diminish this pollution by taxingit. "In an efficient economy," Layard writes, "therewill be substantial levels of corrective taxation ... 60 percent wouldnot seem inappropriate, and that is in fact the typical level of marginaltaxation in Europe—if you allow for direct and indirect taxes."

Prescott responds

Prescott's reactions to these ideas vary widely. Sitting in hisseventh-floor office at the Minneapolis Fed, he reads through thefirst pages of Lindert's paper, then drops it on his desk. "Itdoesn't seem to be coherent," he says.

Davis and Henrekson's study, on the other hand, intrigues him. Thatmight seem predictable given its broad support of Prescott's findings,but Davis and Henrekson employ a technique Prescott generally scorns:statistical regression. "Progress, don't regress," hesays with a smile, quoting the slogan featured prominently on hisInternet home page. Regardless of their method, Prescott is drawnto the findings and has invited Davis to Minneapolis to get a closerlook at their work.

But Prescott's response to Layard's argument—more complete andnuanced—conveys a sense of Prescott himself. He begins by summarizingLayard's case in a phrase: "I'm happy if I have a lot more income—thanyou," he says, grinning and quite aware that he does. As tothe overwork such rivalry might cause, "that just says there'sa consumption externality."

Then he conveys the concept with a story. "I always tried tocreate a positive externality in Pittsburgh for my neighbors who hadthese beautiful lawns," he jokes of his grad school days atCarnegie Mellon University. "By my having a messy lawn, theirlawns looked so much better. I mowed it, but I didn't do much elsewith my lawn. And it gave me utility to see them happier." Hetells the story with a verbal wink, acknowledging silently that hisPittsburgh yard care externality may well have been less than zero.

The conspiratorial smile changes to professorial zeal as he beginsto dissect Layard's reasoning: "Suppose everybody cares aboutrelative consumption as well as own consumption. You work out theequilibrium, it's not Pareto optimal. Let's deal with the case whereeverybody enters symmetrically. So it's simple to make the ordering.Well, you can make everybody better off by just putting a tax on consumptionso that they work less. That's a very standard model. Now what wouldbe the empirical evidence for and against that?"

In under five minutes, Prescott has crystallized an argument, communicatedit to a visitor in plain language and personal anecdote, then convertedit to the idiom of economics and laid out steps for its confirmationor refutation. It's vintage Prescott: analytically brilliant, unexpectedlyfunny and several beats ahead of everyone else. That last bit is theessence of a conversation with the economist. When you ask him a question,it sometimes seems that his reply is off-topic; then it dawns on youthat Ed Prescott is answering the question you should have asked.

A pattern of surprise

Prescott's willingness to entertain alternatives, to listen to critics,to incorporate the unexpected is deeply characteristic of his work.That flexibility is, in fact, the paradoxical outcome of a rigid researchdiscipline. In setting model parameters, for instance, or reportingresearch results, "the investigator has no degrees of freedom,"he says. "You have to tie your hands and if there's a deviationfrom your predictions, you report it. You can speculate on why, butyou've got to be totally honest."

Intellectual honesty also means allowing findings to modify, evensubvert initial hypotheses. It happens frequently, says Prescott.Much of the work for which he's best known—theories on timeinconsistency, real business cycles, the equity premium and growththeory—has been developed in an ongoing process of researchand revelation.

"When I work out the implications, I'm quite often surprised:The findings change my views quite dramatically," he says. "WhenI did the real business cycles work with Finn Kydland, I was certainthat monetary shocks were the reason the economy fluctuated with thebusiness cycles. Our findings were just the opposite. When I did somework with Rajnish Mehra on the equity premium puzzle, I was certainthat the reason for the high historical difference in the return onequity relative to debt was just a premium for bearing aggregate,nondiversifiable risk. We found it wasn't." For time inconsistencyand the impact of taxes on labor supply, as well, surprise has beenan intrinsic part of the process.

Future direction

As striking as his labor supply findings are—and though manyaspects of it remain unresolved—Prescott senses that the bigtheoretical questions in economic growth lie elsewhere, and he isnow turning his attention to them. "I think I've had my sayon labor supply," he concludes.

In his Ely lecture, he lays out three sources of economic growth:capital, labor and productivity. The first two are important in understandingwhy some nations remain poor while others prosper, but the centralquestion, contends Prescott, is what determines productivity? "Givenproductivity, our macro models are great," he says. "Butwe treat it as exogenous. We've got to have a better understandingof mapping between policies and productivity."

In other words, what can governments do to enhance productivity? Prescott'smain candidates are efficient financial markets, competition amongproducers and trading clubs. And currently, the last is his majorfocus.

"What is a trading club?" he asks rhetorically. "Well,first, free movement of goods between the member states. But it'smuch, much more than that. ..."

Prescott continues at length, with a discourse ranging from Toyotafactories in Wales to trade among the U.S. states in the 19th century.He speaks quickly, and as he does there is a sense that each researchquestion he asks leads him to a dozen more, each more interestingthan the last.

He will travel soon to Warsaw and then Bogotá to explore theseideas with other economists and policymakers. "It's going tobe fascinating to see what's happening in Poland," he remarks.In Colombia, "the president is trying to do some good thingsthere, and we have to go down and help out."

He's not a policymaker himself. "I leave that to other people,"he says. "I'm no good at it. My comparative advantage is workingout implications of theory." And in so doing, it seems thereis just one constraint: Even for Ed Prescott, a scholar who understandslabor supply dynamics as well as anyone on earth, there are only 24hours in a day. "Time," observes the economist, "isthe most valuable resource."

1 Thetwo assumptions: (1) that people decide between leisure and consumptionbased on their relative prices, at the margin, and (2) that in a competitivemarket, wages are equal to their marginal product of labor. The "keyequilibrium relation" also depends on the share of a nation'soutput due to capital.