Returns to Experience and the Elasticity of Labor Supply

We use a unique dataset and novel empirical strategy to validate the predictions of labor supply models featuring returns to experience, quantify the bias in standard estimates of the intertemporal elasticity of substitution (IES) that assume exogenous wage formation, and obtain an unbiased estimate of the IES. Our approach uses the insight that the bias in standard estimates shrinks as returns to experience decline in importance relative to the wage. Our identification strategy does not rely on the structure of the human capital accumulation process but does require observing workers over multiple periods at the very end of their careers. Using data on the daily labor supply of Florida fishermen, we obtain an estimate of the IES that is large (2.5). Consistent with the theory, we find that a “naive†estimate is biased downward by nearly a factor of 2 and that the bias is larger for fishermen early in their career. (Copyright: Elsevier)