August 2005

IZA DP No. 1722: Bargaining Frictions and Hours Worked

revised published as "Bargaining Frictions, Labor Income Taxation and Economic Performance" in: European Economic Review, 2010, 54 (6), 778-802

A matching model with labor/leisure choice and bargaining frictions is used to explain (i) differences in GDP per hour and GDP per capita, (ii) differences in employment, (iii) differences in the proportion of part-time work across countries. The model predicts that the higher the level of rigidity in wages and hours the lower are GDP per capita, employment, part-time work and hours worked, but the higher is GDP per hours worked. In addition, it predicts that a country with a high level of rigidity in wages and hours and a high level of income taxation has higher GDP per hour and lower GDP per capita than a country with less rigidity and a lower level of taxation. This is due mostly to a lower level of employment. In contrast, a country with low levels of rigidity in hour and in wage setting but with a higher level of income taxation has a lower GDP per capita and a higher GDP per hour than the economy with low rigidity and low taxation, because while the level of employment is similar in both economies, the share of part-time work is larger.