Differences in hours worked in the OECD: institutions or fiscal policies?

This paper studies the determinants of the level and the evolution of per capita hours worked in a panel of OECD countries since the 1970s. Following Pesaran (Econometrica, 2006), our empirical strategy allows for the possibility of cross-sectionally correlated error terms due to unobserved common factors which are potentially non-stationary. We find that much of the variation in hours worked across countries and over time can be explained by differences in fiscal policy, i.e. differences in the level and structure of taxes and in the structure of government expenditures. Hours worked rise when labour taxes and non-employment benefits fall and when the shares of productive government expenditures and government wage consumption increase. Differences in (the evolution of) labour and product market institutions have much less of a role to play. Our results show that a careful treatment of the time-series properties of the data is crucial.