In this paper we show that globalization might cause an inefficient reduction of working time regulation. The argument rest on the assumption that people care about their relative standing and that national policymakers fail to completely internalize the consumption externality of the increasingly international reference standards.

Markus Knell

English

Research Papers in Economics

     
 
 
  
  
Volume 29, Issue 1 
  
The Work-and-Spend Cycle in a Globalized World 
  
 
 
Markus Knell  
Oesterreichsiche Nationalbank 
Abstract 
In this paper we show that globalization might cause an inefficient reduction of working time regulation. The argument 
rest on the assumption that people care about their relative standing and that national policymakers fail to completely 
internalize the consumption externality of the increasingly international reference standards.
The views expressed in this paper do not necessarily reflect those of the Oesterreichische Nationalbank. 
Citation: Markus Knell, (2009) ''The Work-and-Spend Cycle in a Globalized World'', Economics Bulletin, Vol. 29 no.1 pp. 491-498. 
Submitted: Dec 11 2008.   Published: March 31, 2009. 
 
     1 Introduction
Working time diers considerably across countries. While in the US the average annual
working hours in 2003 have been 1.792, they were only 1.596 in the EU-15 (OECD 2004).
In recent years a number of studies have tried to explain this discrepancy by reference
to dierences in taxes, institutions or preferences (cf. Prescott 2004, and Alesina et al.
2006). The common starting point in this discussion is that the choice of working time
is ultimately a matter of individual preferences and that all regulations above a certain
minimum standard are therefore harmful (cf. IMF 1999, p. 117).
In this paper we want to look at this issue from a slightly dierent perspective. In
particular, we want to argue that an excessive reduction of working time regulation might
lead to suboptimal outcomes, especially if it takes place as a reaction to international
competitive pressures. Such ineciences follow if people care about relative consumption
(cf. Frank 1985, and Weiss and Fershtman 1998). In order to improve their relative
standing in terms of consumption people increase their labor supplies. Insofar as this is
the common practice in society nobody will gain from these \extra hours" in the end and
the only result will be a vicious cycle of work and spend (cf. Schor 1998). In this situation
working time regulations can serve the purpose of counteracting the ineciencies that are
present in the absence of intervention.
National policymakers might, however, fail to fully internalize the consumption exter-
nalities since the developments in communication and information technology have caused
an \internationalization" of reference standards.1 The life style in one country now in-
creasingly inuences the reference standards in other countries and corrective taxes and
working time regulations that have been designed for the closed economy might look inap-
propriate in this new constellation. Globalization and the internationalization of reference
standards might thus induce national authorities to decrease working time regulation be-
yond the level where such a reduction is optimal. Such a situation can be interpreted as
yet another example of a phenomeneon that has been termed the \new systems competi-
tion" (\Competition is bad, when government intervention is good", Sinn 1997, p. 270).
The competition between economic systems about the extent of working time regulation
might reintroduce an international work-and-spend cycle that is similar to the national
work-and-spend cycles that have evoked the working time regulation in the rst place.
In this paper we present a simple model to analyze this argument in more detail.
2 A Simple Model
We assume that there exists a continuum of countries of unit mass and in each country
n another continuum of identical individuals of unit mass. Individual i in country n
cares about his absolute consumption Cn(i) and his relative consumption vis- a-vis to some
1\Large cosmopolitan elements in many populations now take their consumption standards from the
well to do in New York, Milano or Tokyo rather than their domestic exemplars of style and respectability."
(Bowles and Park 2005, F411).
1reference standard Rn(i) that is identical for all individuals in a country (i.e. Rn(i) = Rn).
Absolute and relative consumption are weigthed by 1   n and n, respectively, such
that the total \contribution" of consumption to utility can be written as: Cn(i)   nRn.
The reference standard Rn is composed of a \domestic component"  Cn and a \foreign
component"  C, where  Cn =
R 1
0 Cn(i)di and  C =
R 1
0  Cndn are the average consumption
in country n and the average world-wide consumption, respectively. The relative weight
of the two elements is given by n such that we can write Rn = (1   n)  Cn + n  C. The
internationalization of aspirations can be captured by an increase in the weight n.
The utility function is given by:
Un(i) = ln(Cn(i)   nRn)   Ln(i); (1)
where Ln(i) stands for labor supply. The (homogeneous) wage rate is given by Wn and
the government is assumed to levy a proportional tax n where the proceeds of the tax
are redistributed in a lump-sum fashion. The budget constraint is thus given by: Cn(i) =
(1   n)WnLn(i) + Tn, where Tn = n
R 1
0 WnLn(i)di.2
Since each individual is innitesimally small he will neglect any possible impact of
his own consumption decision on the reference standard ( @Rn
@Cn(i) = 0). This consumption
externality is thus a source of ineciency. Inserting the budget constraint into (1) and
maximizing leads to the competitive equilibrium (denoted by \c"). The labor supply for
the representative individual in country n comes out as:
L
c
n =
(1   n)Wn + nn  C
 [1   (1   n)n]Wn
(2)
Such a labor supply schedule holds for every country n and the continuum of schedules
together with the aggregation condition for  C denes the global equilibrium.
We distinguish between international and national social planners. The national social
planners maximize the utility of their representative individuals. Their social welfare
functions are thus given by:
SWF
nat
n = ln(Cn   nRn)   Ln (3)
The national social planners thereby take the budget constraint Cn = WnLn and the
equilibrium condition  Cn = Cn into account. The international social planner, on the
other hand, maximizes:
SWF
int =
Z 1
0
[ln(Cn   nRn)   Ln]dn; (4)
and he takes not only  Cn = Cn but also  C =
R 1
0  Cndn into account. We assume that
the social planners use the tax rate to implement the optimal optimal labor supplies that
2Here and in the following we assume that the distribution of abilities is suciently compressed, such
all individual optimal plans are feasible in equilibrium: i.e. Cn(i)   nRn  0, Ln(i)  0.
2follow from the maximization of (3) and (4).
3 System Competition and the Ineciency of the
Global Equilibrium
In a later part of the paper we will discuss the case of a two-country model with asymmetric
structures. In this section we will, however, focus on the symmetric case where the
structural parameters of all countries are identical:3
Assumption of International Symmetry
Wn = W; n = ; n = ; n = ; 8n
(5)
From assumption (5) it follows that there will be a symmetric equilibrium with identical
levels of consumption and labor supply in all countries and thus  C = Cn;8n. We can use
this condition in (2) together with Cn = LnWn to derive that for all n:
L
c
n =
(1   )
(1   )
(6)
The maximization of (4) under assumption (5) leads to the optimal solution of an inter-
national social planner:
L
int =


(7)
Comparing (6) with (7) we can observe that the tax rate that implements this optimal
level of international labor supply is given by:

int =  (8)
The tax rate should thus be set equal to the strength of the comparison motive which is
the source of the ineciency of the competitive equilibrium.4 Thereby both the domestic
and the international consumption externalities are completely internalized and world-
wide labor supply equals the value that comes out in the basic benchmark model with
n = 0 and n = 0. The degree of \internationalization"  does not matter for the policy
choice since each unit of consumption produces the same total external eect, independent
of whether this external eect is primarily a domestic or a foreign phenomenon. For the
optimal internalization only the concern for relative standing  matters.
The assumption of an international social planner is, however, primarily a theoretical
possibility. In reality we rather observe a situation where national policymakers act in an
3In particular we assume that the structural parameters Wn, n and n are identical across countries.
The identity of the tax rates then follows from the assumption that also the behavioral responses of the
social planners are symmetric.
4This result can also be found in the related literature (e.g., Ljungqvist and Uhlig 2000, Abel 2005,
and Alvarez-Cuadrado 2006).
3uncoordinated way such as to secure the competitiveness of their countries. The optimal
levels of labor supply and the corresponding tax rate following from the maximization of
(3) are:
L
nat =



1   (1   )
1   

(9)

nat = (1   ) (10)
Comparing (9) with (7) and (10) with (8) we can conclude that the tax rates chosen by
the national social planners are ineciently low and the labor supplies are ineciently
high. Both countries could be made better o by setting taxes equal to the rst-best level
 =  which is associated with the rst-best level of working time L = 
. However, these
levels will not be chosen by the uncoordinated national social planners that disregard the
cross-country spillovers due to the international component of the reference standard.
The case of a closed economy corresponds to a situation with  = 0. In this case (9)
reduces to Lnat = 
 and (10) to nat = . Obviously, in this case the optimum of the
national planner coincides with the one of an international planner. By setting nat = 
the national planner can completely internalize the consumption externality and achieve
the optimum allocation.
If the process of globalization, however, leads to a \shrinking of the world" and a
general increase in  then this will induce the national policymakers to decrease the tax
rate (@nat
@ < 0). As a consequence the labor supplies in all countries will increase which
is suboptimal. In fact, as shown in (7) and (8), the optimal reaction to an increase in
 would be to simply ignore it since only the overall importance of relative standing 
matters and not the distinction between the domestic and the foreign component.
The ineciency of the national equilibrium follows from the fact that the reach of
nation states in this model is smaller than the reach of economic activities and perceptions.
National social planners are not powerful enough such as to enforce policies that internalize
the externalities completely. This is in fact the mirror image of the ineciency of the closed
laissez faire economy where each individual is too weak to implement the ecient solution
and only government intervention can restore the optimal equilibrium. The separated
countries in the multi-country model correspond to the individuals in the single-country
economy insofar as they are also too small to enforce the ecient equilibrium. In a
globalized world where countries compete against each other the ineciencies for which
the government interventions have been established in the rst place reemerge on the
larger scale. As noted in the introduction, this is just another example for the problematic
aspects of \systems competition" that has been studied by Sinn (1997, 2003).
4 The Asymmetric Case
In order to show that competition among countries in terms of working time regulation
might lead to an inecient outcome it was sucient to concentrate on the case of interna-
tional symmetry ((5)). In this section we want to briey deal with the case of asymmetries
4in the case with two countries, H and F.5 We can follow similar steps as above and derive
the optimal tax rates chosen by the national and the international social planners:

int
H =
[1   H(1   F)   (1   F)F]HWF + FFWH
[1   (1   F)F]WF + FFWH
(11)

nat
H = (1   H)H (12)
Parallel expressions hold for int
F and nat
F . We want to deal with two cases: an unilateral
increase in H while F stays constant and a general increase in  where H = F = .
Unilateral increase in H (for constant F). This case corresponds to a situation
where some (rich) countries are continuously gaining inuence on \international reference
standards" due to the development of world media and the internet. Such a process could
be further aggravated if people primarily make upward comparisons (and F is the richer
country). If H increases then we see from (12) that a national planner will decrease the
tax rate in country H while the one of country F will stay constant. This will cause an
increase in labor supply in H. But since an increase in LH will also increase the reference
standard in country F (as long as F > 0) we can conclude that in the case of national
social planners an increase in H will lead to more labor supply in both countries. An
international social planner on the other hand will behave dierently. In particular, it
can be shown that
@int
H
@H < 0 and
@int
F
@H > 0 and thus also
@Lint
H
@H > 0 and
@Lint
F
@H < 0 where
@Lint
F
@H =  
@Lint
H
@H . An international social planner will thus hold the total world labor supply
constant while allowing for a shift in the labor between the two countries. This follows
from the fact that the rise in H increases the total external eect of the consumption
level of country F. The optimal reaction to this change is to raise the tax rate int
F . By
the same logic the corrective tax in country H can be allowed to decrease.
General increase in H = F = . This case captures a general ratcheting up of the
international components of reference norms. Now national social planners will decrease
taxes in both countries (cf. (12)). This will thus have an even larger positive eect on the
labor supplies in both countries than in the rst example. This outcome leads again to
an inecient situation. An international social planner will also implement tax changes
but again in a way such that
@Lint
F
@ =  
@Lint
H
@ , i.e. such that the average world-wide supply
of labor stays constant. The distribution of the labor supply changes between the two
countries is now ambiguous and will depend on the relative structural situation of the
two countries. For the tax rates we can show that
@world
H
@ < 0 for
H
1 H
1 F
F
WH
WF < 1.
Thus, a reduction in world
H is more likely to be optimal when country H is relatively poor
5This assumption is made for simplicity. In this case we assume that the reference standards for the
two countries is given by: RH = (1   H)  CH + H  CF and RF = (1   F)  CF + F  CH. Furthermore,
we assume that the national social planners disregard a possible impact of domestic consumption on the
foreign part of the reference standard (i.e. @  CF
@CH = 0 and @  CH
@CF = 0).
5(WH < WF) and if its concern for relative standing is comparatively weak (H < F). It
is important to note, however, that in case where the optimal reaction to an increase in 
is to decrease world
H it must be accompanied by an increase in world
F (i.e.
@world
H
@ < 0 ,
@world
F
@ > 0). An universal race to the bottom in working time regulation and corrective
tax rates is never the optimal reaction to a general rise in the importance of international
reference standard. This is the main dierence to the situation where national social
planners compete with each other and where systems competition might cause a harmful
cycle of working time deregulation.
5 Conclusion
In this paper we have presented a model that shows that the competitive reduction of
working time regulations might lead to suboptimal outcomes if the involved countries
do not fully internalize both domestic and international consumption externalities. One
conclusion from this analysis is that international agreements concerning working time
(like the ILO conventions and the EU directives) serve a reasonable purpose inasmuch
as they help to internalize this international externality. Of course the simple model
presented in this paper cannot say much about the details of the regulation concerning
daily, weekly, monthly and lifetime working time. Without doubt there exists room for
improvement in the existing legislations along all of these dimensions. Nevertheless, the
results of the model sound a warning not to throw out the baby with the bathwater. Some
internationally agreed regulation of working time is necessary to deal with domestic and
global consumption externalities and to prevent systems competition in an area that is
essential for peoples' welfare.
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7

The Work-and-Spend Cycle in a Globalized World

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