Indivisible Labor and Its Supply Elasticity: Do Taxes Explain European Employment?
We first scrutinize and challenge Prescott's (2002, 2004) quantitative analysis of the role of differences in taxes in explaining cross-country differences in labor market outcomes, and then defend an alternative model that assigns an important role to cross-country differences in social unemployment insurance institutions that Prescott argues can be safely ignored. In the process, we explore how the assumption of indivisible labor interacts with assumptions regarding the (in)completeness of financial markets and any frictions in the labor market, to determine the labor supply elasticity.
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