Labor Market Dynamics in Developing Economies: the Role of Subsistence Consumption

Motivated by the recent empirical evidence on a strong negative relationship between the income level and hours worked across countries (Bick, Fuchs-Schundeln, and Lagakos (2018)), this paper establishes new stylized facts on labor market dynamics in developing economies. First, the response of hours worked (and employment) to a permanent technology shock- identified by a structural VAR model with long-run restrictions- is smaller in developing economies than in advanced economies. Second, the level of income per capita is strongly and robustly associated with the relative variability of hours worked and consumption to output across countries. We build a simple RBC model augmented with subsistence consumption to explain the set of new empirical findings. The minimal departure from a standard RBC model allows us to account for the salient features of business cycle fluctuations in developing economies, including their distinct labor market dynamics.