Wages ; Labor market ; Labor supply ; Employment (Economic theory)

Daniel Aaronson

Eric French

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK AUGUST 2000
OF CHICAGO NUMBER 156
Chicago Fed Letter
Part-time work and
hourly wages
Many studies find a correlation between
how much a worker is paid (per hour)
and how many hours she works. The
usual causal interpretation of this cor-
relation is that those with lower wages
choose to work fewer hours. However,
it is also possible that those who work
fewer hours are offered lower wages.
We find evidence that the latter interpre-
tation may be relevant as well, at least for
older workers. This means that research-
ers are potentially overestimating the
response to work incentives of high
wages. This is important because tax
cuts are viewed as similar to increases
in the wage. Therefore, unless labor
supply analyses account for the fact that
part-time workers earn less than full-time
workers, the work disincentives of taxes
may be overestimated. This Chicago Fed
Letter summarizes the nature of this
problem, our empirical solution, and
some public policy issues related to it.
Problem and related policy issues
When economists predict how much
an individual will work, it is typically
assumed that the worker receives a
wage offer and then optimally chooses
the number of hours to work based on
outside opportunities, such as family
responsibilities, wealth, and their
spouse’s income. With the exception
of overtime hours, it is presumed that
workers receive a constant wage rate
regardless of hours worked. However,
this is not necessarily the case. Rather
the wage offered to workers may be
determined by the number of hours
worked by an employee.
Why would the number of hours an
employee works affect their hourly
pay? One explanation is that there are
fixed costs of employment, such as hir-
ing and training. In many situations,
these fixed expenses make part-time
workers more expensive to employ per
hour at a given wage than full-time
workers because the fixed costs must
be spread over fewer hours of work.
This is particularly relevant for many
European countries, where fixed em-
ployment expenses are the result of
the high regulatory cost associated with
hiring and firing employees. But it is
also applicable to U.S. labor markets,
where lump sum benefits, most notably
health insurance, are often not tied to
hours worked.
From a research perspective, the rela-
tionship between hourly wage rates and
hours worked is a fundamental empiri-
cal problem in labor economics. Stan-
dard labor supply models that estimate
the impact of the wage rate on whether
and how much someone works (the
wage elasticity) only make sense if
wages do not depend on hours worked.
Otherwise, lower wage offers at lower
hours worked bias estimates of the typi-
cal individual’s wage elasticity. There-
fore, it is important to know the causal
correlation of hours to wages not just
to estimate a part-time wage effect but
to properly estimate workers’ labor
supply responsiveness to wage offers.
From a policy perspective, the compu-
tation of the wage elasticity is the key
parameter in designing work incentives
in public programs. For example, a
properly estimated relationship between
hours and wages can be applied to the
debate over the level and progressivity
of taxes. Advocates of lower and less
progressive taxes often appeal to the
benefits of labor supply incentives. Their
assumption is that workers work more
hours if their post-tax wage is higher.
The extent to which workers do supply
more hours to the market when their
after-tax wage is high is usually answered
by observing the correlation between
wages and hours.
Furthermore, the part-time/full-time
wage differential is itself useful for
understanding a variety of labor market
issues. After all, part-time work is con-
siderable; at any point in time in 1999,
approximately 17% of U.S. workers
were part-time. Some instances when
the part-time/full-time decision is par-
ticularly relevant include transitions
into and out of the labor force. For ex-
ample, Ruhm (1990) has documented
the role of part-time or bridge jobs in
the retirement process.1 His work sug-
gests that over half of workers take
part-time jobs, many in industries and
occupations outside their career job,
before fully retiring. Therefore, to fully
model the dynamics of retirement, we
must understand the tie between wages
and hours.
Despite the research and policy impor-
tance of this question, many estimates
of the part-time wage effect are not per-
suasive. The fundamental problem is
that when an analyst observes a positive
correlation between hours and wages it
is not clear whether the positive correla-
tion is caused by firms offering higher
wages for more hours worked or whether
workers supply more hours to the mar-
ket when their wage is high.
One common strategy to solve such a
simultaneity problem is to come up with
a third variable, an instrument, that is
correlated with hours but not directly
with wages. In such a case, the variation
in the instrument should cause variation
in wages only through its effect on vari-
ation in hours. Consequently, the instru-
ment will be correlated with wages only
if part-time workers make less than full-
time workers.
Past studies of part-time wage effects
have used the number of young children
in the household and other childbear-
ing demographics as an instrument in
a sample of full- and part-time female
workers. The reasoning is that having
young children reduces a mother’s avail-
able time for work. Since the mother
works fewer hours, she receives a lowerwage if part-time workers receive lower
wage offers. However, this is a valid
strategy only if young children affect
hours worked but do not directly affect
wages (say, through unmeasured pro-
ductivity changes). If young children
also restrict the mother’s job opportu-
nities, perhaps because the mother must
take a job that also provides day care,
then the mother would have lower wages
not because she was a part-time worker
but because she faced other work restric-
tions. This would lead to an overestima-
tion of the effect of part-time work upon
wages. Examples using such strategies
result in estimates of the part-time/full-
time wage differential of up to 30%.
New estimates
Our estimation of the part-time wage
differential uses a different identifying
strategy than previous studies.2 We take
advantage of what we believe is a better
instrument for the employment deci-
sion, i.e., the work disincentives of the
Social Security system.
Most individuals become eligible for
Social Security benefits for the first time
at age 62. Many of these workers would
like to retire before age 62 but cannot
because they need Social Security ben-
efits. Between ages 62 and 69, individu-
als face the Social Security Earnings
Test, which is a high tax rate on labor
income above a certain threshold and
is in addition to federal and state income
and payroll taxes. Between ages 62 and
64 benefits lost through the Earnings
Test are replaced in the form of higher
benefits in the future, resulting in about
a dollar of higher benefits in the future
for every dollar lost through the Earn-
ings Test. After age 65, however, benefits
lost through the Social Security Earnings
Test result in only small increases in
future benefits. Therefore, the Social
Security Earnings Test results in a strong
incentive to retire by age 65.
Another reason the Social Security sys-
tem provides incentives to exit the labor
market by age 65 is that for many work-
ers, health insurance is linked to their
job until age 65. Many individuals would
lose their health insurance if they were
to retire early.  At age 65, all individuals
who are eligible for Social Security are
also eligible for Medicare. This means
that most individuals who are age 65
and older have reasonable quality
health insurance even after they leave
their jobs.
The results of these work disincentives
can be seen in figures 1 and 2. These
figures graph the average number of
hours worked by age for working men
and women in the Panel Study of In-
come Dynamics (PSID), a survey that
has been following the same families,
and their offspring, since 1968. Figure
1 displays the average number of hours
worked per week for working men
aged 50 to 70, and figure 2 reports the
analogous graph for married women.
For men, hours slowly begin to decline
around age 55 but the biggest drops
occur after age 61. Between ages 61 and
62, annual work hours decline 11% from
1,870 to 1,670 hours per year. Hours
fall a bit more at ages 63 and 64 before
another large 10% drop at 65. After age
65, hours level off. Therefore, the larg-
est declines are at ages 62 and 65. For
married women, the picture is even
clearer. Hours decline slowly through
age 61 but drop 6% at age 62 and 10%
at age 65.3 These graphs suggest that
Social Security and Medicare laws may
play a role in the labor supply decisions
of older workers.4
Figures 3 and 4 display average wages
for the same PSID working men and
married women between the ages of 50
and 70. For men, wages remain rela-
tively flat, with perhaps some modest
overall decline, between ages 50 and
61. But at age 62, the average wage of
working men drops by 3%. This de-
cline continues from ages 64 through
67, with the biggest drop, 5%, occur-
ring at 65. After age 67, wages flatten
out again. For women, the age 62 and
65 drops are starker. Wages actually in-
crease up through age 61 (this is only
for older working women and thus se-
lectively includes those who are doing
the best in the labor market) but drop
by 6% at age 62, remain roughly flat at
63 and 64, and drop again at 65. After
age 65, wages are volatile because of
small sample sizes.
Taken together, figures 1–4 suggest a
possible causal relationship between
hours and wages. The biggest drop in
wages occurs at ages 62 and 65, the
same ages at which the Social Security
work disincentives kick in. This sug-
gests to us that turning age 62 and 65
are possible instrumental variables that
can be used to identify the part-time/
full-time wage differential.
To properly estimate the part-time effect,
we must account for several confound-
ing factors. First, part of any age 62
or 65 effect may be due to the natural
aging process. Labor force participation,
hours, and wages follow a well-docu-
mented life-cycle pattern; at older ages,
these variables begin to fall for a number
of reasons, including the consequences
of declining human capital. Human
capital theory posits that near the end
of the life cycle, workers should invest
less in skill development, as they have
fewer years left in the labor market to
recoup the investment. Therefore, wag-
es should decline as remaining skills
decline in value. Declining wages at the
end of the life cycle potentially induces
annual hours
Note: The vertical lines indicate ages 62 and 65.
Source: University of Michigan, Institute for Social
Research, Survey Research Center, 1968–97,
Panel Survey of Income Dynamics, Ann Arbor, MI.
1. Hours worked, men
age
50 55 60 62 65 70
900
1,400
1,900
2,400
annual hours
Note: The vertical lines indicate ages 62 and 65.
Source: University of Michigan, Institute for Social
Research, Survey Research Center, 1968–97,
Panel Survey of Income Dynamics, Ann Arbor, MI.
2. Hours worked, married women
age
50 55 60 62 65 70
900
1,100
1,300
1,500
1,700Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research;  Douglas
Evanoff, Vice President, financial studies; Charles
Evans, Vice President, macroeconomic policy research;
Daniel Sullivan, Vice President, microeconomic policy
research;  William Testa, Vice President, regional
programs and economics editor; Helen O’D. Koshy,
Editor.
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Research Department of the Federal Reserve Bank
of Chicago.  The views expressed are the authors’
and are not necessarily those of the Federal
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ISSN 0895-0164
declining hours worked at the end of
the life cycle. We solve this potential
problem by adjusting all hours and
wage numbers by the age of the worker.
We must also show that there are no
other reasons for wages to drop at ages
62 and 65. Our working paper (see
note 2) describes a number of reasons
why this assumption might be wrong.
Briefly, we highlight two here. First,
hour levels within jobs are typically
fixed. Therefore, much of the variation
used to identify hour changes comes
from job switchers. As a result, we must
be careful that any wage change is due
to an hours change and not to produc-
tivity changes that may result from the
loss of industry-, firm-, or job-specific
human capital. One way we deal with
this problem is by looking at workers
who have not switched jobs. We find
that even among continuously em-
ployed workers, both hours and wages
have sharp drops at ages 62 and 65.
Second, firms may structure their com-
pensation and pension plans in order
to encourage workers to leave by age
62 or 65. Some economic theories im-
ply that employers offer compensation
below the productivity of the worker
when she is young but reward her with
compensation above her level of pro-
ductivity at the end of her career. This
large payday when old motivates
young workers to work hard. Howev-
er, this scheme potentially influences
the worker to remain with the firm
too long. In order to induce the worker
to leave, firms often offer low pension
accrual to employees in their 60s. This
induces workers to leave their old,
high wage job for new jobs with poten-
tially lower wages. Therefore, there
may be a drop in wages at ages 62 and
65 because workers are moving to jobs
with lower wages, not because they are
working fewer hours. To get around
this problem, we look at samples of
workers who do not have pension
plans. Even among workers without
pension benefits, wages decline sharply
at ages 62 and 65. Moreover, workers
who remain at the same firm have
wages that sharply drop at these ages.
Our full results are described in detail
in our forthcoming working paper.
Briefly, we find evidence that part-time
workers earn lower wages. Depending
on the specification and the data em-
ployed (we use three different data
sets), these estimates imply that cutting
hours from 40 hours per week to 20
hours per week lowers wages by approx-
imately 20% to 40%. Many of our esti-
mates are significant at the 10% level
or higher. These estimates are generally
larger than estimates using samples of
mothers with young children.
Conclusion
Our research suggests that lower work
hours may cause lower wages among
a nationally representative sample
of older workers. This means that re-
searchers are potentially overestimating
the response to work incentives of high
wages, at least for this age group. This
dollars per hour
Note: The vertical lines indicate ages 62 and 65.
Source: University of Michigan, Institute for Social
Research, Survey Research Center, 1968–97, Panel
Survey of Income Dynamics, Ann Arbor, MI.
3. Hourly wage, men
age
50 55 60 62 65 70
8
10
12
14
dollars per hour
Note: The vertical lines indicate ages 62 and 65.
Source: University of Michigan, Institute for Social
Research, Survey Research Center, 1968–97,
Panel Survey of Income Dynamics, Ann Arbor, MI.
4. Hourly wage, married women
age
50 55 60 62 65 70
6.5
7.5
8.5
9.5
is of central importance because tax
cuts are viewed as similar to increases
in the wage. Therefore, unless labor
supply analyses account for the fact that
part-time workers earn less than full-time
workers, the response to work disincen-
tives of taxes may be overestimated.
—Daniel Aaronson
Senior economist
—Eric French
Economist
1Christopher Ruhm, 1990, “Bridge jobs and
partial retirement,” Journal of Labor Economics,
Vol. 8, No. 4, pp. 482–501.
2For more details, see Daniel Aaronson and
Eric French, 2000, “Do part-time workers have
lower wages than full-time workers? Evidence
from the Social Security budget constraints,”
Federal Reserve Bank of Chicago, working
paper, forthcoming.
3Similar pictures of the age 62 and 65 hours
decline can be seen in the Current Population
Survey (CPS), the government’s main source
of hours and employment data.
4For more formal evidence on the labor supply
effects of social security laws, see Eric French,
2000, “The effects of health, wealth, and wages
on labor supply and retirement behavior,”
Federal Reserve Bank of Chicago, working
paper, No. 00-02.P
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The Midwest purchasing managers’ composite index (a weighted average of the
Chicago, Detroit, and Milwaukee surveys) for production increased to 57.4% in
June from 55.2% in April. The purchasing managers’ index increased in all three
surveys. The national purchasing manager’s survey decreased from 56.3% to 53.6%
during this period.
The Chicago Fed Midwest Manufacturing Index (CFMMI) rose 0.3% from April to
May, reaching a seasonally adjusted level of 164.9 (1992=100). Revised data show
the index was at 164.5 in April, up 0.6% from March. In comparison, the Federal
Reserve Board’s Industrial Production Index for manufacturing (IP) increased
0.3% in May, after rising 0.6% in April. Light truck production decreased slightly
from 7.2 million units in April to 7.1 million units in May and car production also
decreased slightly from 5.8 million units in April to 5.7 million units May.
Sources: The Chicago Fed Midwest Manufactur-
ing Index (CFMMI) is a composite index of 16
industries, based on monthly hours worked and
kilowatt hours. IP represents the Federal Reserve
Board’s Industrial Production Index for the U.S.
manufacturing sector. Autos and light trucks are
measured in annualized units, using seasonal ad-
justments developed by the Board. The purchas-
ing managers’ survey data for the Midwest are
weighted averages of the seasonally adjusted pro-
duction components from the Chicago, Detroit,
and Milwaukee Purchasing Managers’ Association
surveys, with assistance from Kingsbury Interna-
tional, LTD., Comerica, and the University of
Wisconsin–Milwaukee.
1997 ’98 ’99 ’00
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56
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Purchasing managers’ surveys (production index)
Purchasing managers’ surveys:
net % reporting production growth
June Month  ago Year ago
MW 57.4 55.2 63.9
U.S. 53.6 56.3 62.5
Motor vehicle production
(millions, seasonally adj. annual rate)
May Month  ago Year ago
Cars 5.7 5.8 5.5
Light trucks 7.1 7.2 7.1
Midwest
U.S.
Manufacturing output indexes
(1992=100)
May Month  ago Year ago
CFMMI 164.9 164.5 152.8
IP 149.7 149.3 142.8
Tracking Midwest manufacturing activity
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Part-time work and hourly wages

http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2000/cflaug2000_156.pdf

Part-time work and hourly wages

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Research Papers in Economics