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Nobel Prize winner Dr. Claudia Goldin’s research explains the increasing propensity of American women to enter the workforce.

By John Beattie

Edited by Thomas Ku

Last month, Harvard professor Claudia Goldin was awarded the Nobel Memorial Prize in Economic Sciences “for having advanced our understanding of women’s labour market outcomes.” A true empiricist, Goldin sifted through centuries’ worth of labor market data to uncover a story about female labor supply decisions. While the committee has historically awarded researchers for their respective research methods as opposed to their findings, Goldin is being recognized for both. Moreover, some of her most important findings have aged especially well and can help us understand broader trends in the current labor market.

Her research is particularly useful for understanding female labor force participation decisions. Her 1994 paper, “The U-Shaped Female Labor Force Function in Economic Development and Economic History,” sheds light on the relationship between female labor supply decisions, economic circumstances, cultural norms, and familial obligations. As rich countries get richer throughout generations and wages rise, females—particularly married women—are more likely to enter the labor force at the margin. Conversely, as poorer countries get richer and wages naturally rise, females are more likely to drop out of the labor force. Hence, the function mapping married women in the workforce over time is U-shaped. Here is an especially helpful illustration, courtesy of the Nobel Prize press release:

In words that economists prefer, the substitution effect dominates the income effect on the right-hand side of the chart where wages are higher, and vice-versa. To define the terms income and substitution effect, we can proceed with the following thought experiment: would someone work more if their hourly wage were $20 or $10? If they would work more if their wage were $20 per hour, that suggests that the substitution effect dominates. With respect to the labor supply decision of mothers, the reason the substitution effect dominates could be that high wages make it too “expensive” to stay home and take care of their child. If they choose to work more if their wage were $10 per hour, that suggests that the income effect dominates. With respect to the labor supply decision of mothers, the reason the income effect dominates could be that these lower wages force mothers to increase their working hours in order to purchase their usual bundle of household goods. Both of these effects work in opposite directions for inferior goods—goods for which demand declines as income increases. Note also that there is no morally or optimally correct choice to this question. Much empirical work in economics focuses on this question, but the illustration above encompasses the basic idea.

Now, with newfound knowledge on the informal definition of the effects at work here, what can be said about female labor supply choices in the U.S.? Data on the rate of dual-income households and inflation-adjusted wages would give us a solid answer to this complex question. First, here is a graph of inflation-adjusted wages since 1960:

Note that the sudden spike and trough in 2020 are due to a compositional effect stemming from the COVID-19 pandemic. Low-wage workers are the first to get fired and the last to get hired in a recession, skewing earnings data. In other words, nothing notable is occurring here with respect to worker choice, per se. BLS reports show that real earnings are currently increasing along the trend.

And as for dual-income families, the rate has increased steadily over the same period. Here is the female labor force participation rate:

What is going on here? Why are more women working when wages are higher? The answer is that the substitution effect dominates. In other words, women entering the workforce would answer “$20” to the prompt above, as higher wages pull them into the labor market.

For some, this concept is not quite as intuitive. A pessimist may see rising female labor force participation rates and argue that this is indicative of a struggling society in which families are so desperate for income that mothers reluctantly enter the labor force. However, an empiricist would suggest that society is struggling less over time, at least in terms of real earnings. This is why females are entering the labor force now more than ever before. The opportunity cost in the form of wages that a strong labor market provides is too high for them to be a full-time parent.

From this viewpoint, Goldin’s work has aged especially well. She concludes that the substitution effect tends to dominate income effect in high-income countries and this is effectively what is driving the labor market. This phenomenon should remind us of the role of both empirical evidence and theory. Without any empirical evidence, there is potential to fall into the trap of assuming that women are entering the workforce out of dire conditions seen in poorer countries, such as extremely low wages and an inability to outsource childcare. Without the theory of the substitution effect, one would have a difficult time explaining why real earnings and a rise in dual-income families are correlated. Goldin checks off both of these boxes, and her ingenious model of female labor supply decisions remains relevant in helping us contextualize U.S. economic trends today.