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Estimation of the Labor Force Supply Function in Iranian Provinces
Mosayeb Pahlavani Hanieh Safamaneshand Foroogh Jahantigh
Abstract
The labor force economic activity index rate is among the main criteria used in evaluating
economic progress in most countries, especially developing countries. Labor force economic
activity index rate has been defined as the percentage of individuals who are eligible for
work, either employed or pursuing a career. Naturally, the greater the economic participation
rate, the higher economic growth. However, it is important to recognize the factors that play
significant roles in the formation, increase or decrease of active population and consequently
determines the economic activity rate. The present study aims to find a suitable answer to the
following question: What are the effective factors on the formation of economically active
population in the Iran's Provinces? We applied Panel Data approach in order to estimate
supply of labor force in 28 provinces of Iran. Our empirical finding shows that there is a
positive and significant relationship between the key variables, i.e., wage and economic
participation rate. Other variables such as type of employment, GDP per capita, and number
of employees in the economic sectors, have been listed as control variables. Ultimately, due
to the significance of wage and remuneration policies in the variation of participation rates,
appropriate measures have been taken by the government for increasing productivity and
consequently supply of the labor force as well as deployment of macroeconomic policies
based on the present social situation that seems to be necessary.
Key Words: Labor force Supply, Economic Participation, Remuneration Rate Attraction, and
Panel Data.
JEL Classification: J20, J21.
Introduction
The labor market consists of two main parts: Supply of the labor force and the demand
expressed by employers for services that offered by such labor force. The goal is to achieve a
correct pattern for remuneration, employment, and income.

Corresponding Author: Dr. Pahlavani is an Associate professor of Economics, University of Sistan &
Baluchestan, Iran

MA Students in Economics, University of Sistan & Baluchestan, Iran.
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In the majority of empirical studies, the main point is labor force. Labor force in this respect
is an entity with a potential to acquire combination of capabilities, knowledge, and
characteristics that emerge as the collective ability to do work in order to produce economic
values. Training and experience are essential to achieve such a qualified ability.
Therefore, taking into account various performances of the labor market especially
requirements of the labor force in terms of employment, planning, and policy making
decisions would be inevitable in this regard.
The volume of labor force supply is influenced by the different age groups in the population
who are eligible for work (in Iran, this different age groups include the population of ten
years old and over), as well as the percentages in such age groups who actually participate in
the economic activities. Thus, variations in volume of the population within the above
mentioned different age groups would greatly influence the volume of labor force supply.
Due to the importance of this issue, in the year of 2000, Iranian Statistic Center started to
perform the annual project in order to collect information about the employment status of the
Iranian families, and in 2005, started to do the annual sample survey of the status quo of the
labor force in Iran. Upon the completion of these surveys, statistical information regarding
the employment status of Iranian people was made available and this explains why the 20002008 periods have been selected for evaluation in the present research.
The economic participation-related information is given in the following table:
Table 1- Economic participation rate for the period of 2000- 2008
Sample
variable
Man and
Economic
Woman
participation rate
2000
2001
2002
2003
2005
2006
2007
2008
19/37
37/23
37/2
38/1
41
40/4
39/8
38
Source: Iranian Statistic Center
Knowledge about the factors that bring economic participation/influence, and its
increase/decrease as well as recognizing the extent of this influence, can help policy makers
to evaluate the labor force supply model for Iran's provinces. Therefore, we put forward our
main questions in this research as follows:
1- How the increasing wages have a significant effect on the rate of economic
participation in Iran?
2- How come the effect of extra workers as a result of variations in the unemployment
rate has being dominant effect in the rate of economic participation?
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3- If there is a rise in the number of service sector's employees, would it increase the rate
of economic participation or not?
In Section 2, there are some of the leading studies which conducted in the field of labor force
supply, in Section 3; the theoretical fundamentals of the proposed model are briefly reviewed.
Sections 4 and 5 are dedicated to the results obtained from the approximation model and the
overall conclusions drawn from the research as a whole, respectively.
2. Literature Review
Upon having studied more than 759 articles in six authentic journals reflecting the modern
literature used today to discuss labor force supply, Stafford (1986) concludes that labor force
economists are unanimous on two points: Men do not react to the variations introduced in
their wage/income, and women are particularly sensitive to such variations.
Kottis (1990) believes that women’s activity rate in Greece is function of men’s and women’s
unemployment rate, employment rate in the agricultural sector, extension of urbanism,
population growth rate, percentage of women 10 years old and over in the entire population
of women without elementary education, percentage of individuals under 10 years in the
whole population, percentage of unmarried women 10 years old and over in the total
population , and percentage of men 10 years old and over outside the labor force.
Leoni (1994) investigates the labor force supply in Italy from two points of view: Keynesian
and neoclassical. According to the neoclassical theory, activity rate is defined as a function of
unemployment rate. Leoni believes that while the unemployment rate variable coefficient is
positive for some functions and negative for other functions, activity rate is always directly
proportional to other variables. Results of tests conducted on the two models show that the
labor force activity rate responds well to both variable groups, and so, neither model could be
preferred to another one.
According to Tanda (1994) women’s labor force activity rate is, a function of women’s to
men’s hourly remuneration ratio, women’s and men’s unemployment rate, high school and
university education rate, marriage rate, ratio of the 4years old and under to the entire
population, ratio of the urban population to the whole population, average duration of
marriage before the occurrence of divorce, and divorce rate.
Therefore, women’s activity rate is indirectly proportional to women’s remuneration rate,
women’s unemployment rate, ratio of the urban population to the total population, and
average duration of marriage before the occurrence of divorce, and directly proportional to
other factors.
In Elhorst’s (1996) view, economic participation is a function with a negative coefficient of
unemployment rate, and a positive coefficient of the followings:
The population group under 25, the population group between 25-44, share of employment in
the service sector, average rate of remuneration, and educational progress made by the
population in the different age groups who are eligible for work. According to Elhorst, such a
model is in agreement with the Keynesian view.
Merz (2006), in his study titled “Supply of Women’s Collaborative Work: Documents from
Germany”, points out that during the past two decades, the nature of women’s labor force
supply has been transformed in such a way that women’s employment rate is steadily
increasing. In his view, such transformation in women’s employment status is influenced by
characteristics such as women’s education, their partner’s (spouse’s) working hours, and
number of small children in the family.
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In an article titled “Education, Supply of Labor force and Local Market Development in
Rural Peru”, Laszlo (2008) refers to the key role of education in people’s engagement in
more profitable activities, and consequently their higher earning income as well as enjoying
more leisure time. In addition to the role of education in reducing poverty, the author
introduces another effective, instrumental variable, i.e., local market development in rural
areas. Laszlo believes that investing in education, though useful, offers a slow yield (return),
while investing in local market development produces quick returns through creating more
job opportunities and consequently fewer working hours which would lead to reduction of
domestic work in the family and increase of social activity, and this, in turn, would bring a
reduction in the number of working children, as well as other benefits for the rural
population.
3. Background
Falihi (2000) calculates the labor force supply function; we assume the ideal function U for
an individual to be3:
U = f (x, n, A, ε)
Where x is the amount of goods and services consumed by the individual, n the number of
working hours, A the individual’s characteristics, and ε the individual’s taste, and we have
U
U
 0‫و‬
0
n
x
In this model, the budget constraint can be written as
P.x  w.n  M
x0
M 0
Where, P is the commodity price index, w the wage rate, and M the independent income (not
earned income from working). Now, if we maximize the ideal function in terms of its
constraint, the following equilibrium condition is obtained
w
U / n
 m( x, n, A,  ) 
P
U / x
Where, m is the final rate of substitution of the work for commodities equal to the real wage.
Finally, the commodity demand function and the working hours supply function can be
obtained as (Falihi, 2000)
X  x( P, w, M , A,  )
n  n( P, w, M , A,  )
3
This model is introduced for static conditions.
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According to Pencavel (1986) above method is standard procedure to obtain the labor force
supply and this is a guide for the most economists that derived from the Hicks’s general
model of consumer demand. According to the above mentioned theory, we introduce the
model used in this study.
LRACT = F (LWAGE, LUEM, LGDPP, LAGR, LIND, LSER)
Introduction of Variables:
LRACT: logarithm of economic participation rate
LWAGE: logarithm of wage rate
LUEM: logarithm of unemployment rate
LGDPP: logarithm of gross domestic product per capita
LAGR: logarithm of agricultural sector employees’ share
LIND: logarithm of service sector employees’ share
4. The experimental Results
As the first step in estimation using the Panel Data Method, we will look for an answer to the
following question:
Would the behavioral pattern (model) for the dependent variable, i.e., the economic
participation rate, be the same for different individuals? If the answer to this question is
affirmative, we would have a compound/simple regression called pooled regression.
However, in the case of a negative answer, the model is referred as the Panel Model which
represents a behavioral pattern where the dependent variable is not the same for different
people.
Liemer’s F test has been used in this case. As shown in Table 1, the theory based on the same
behavior in all the samples and models is rejected in this case. Therefore, the given models
should be evaluated by applying the Panel Data Method.
In the second stage, the Huasman (1978) Test is implemented to investigate whether the
individual effects are random or fixed4? Huasman used a Sample Wald Function to do test the
theory which holds that, there is no correlation between exogenous variables and disturbance
elements.
In Table 2, the Chi-Square Test, statistics shows that there is no correlation between random
effects and exogenous variables in any of the listed models. Therefore, we conclude that
random effects would bring about better specifications.
4
In fact, we are trying to answer the following question: “Are the random effects or exogenous variables
uncorrelated or not?”
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Table 2. Results of F Limmer and Hausman Test
sample
Total
Huasman Test
Chi-
(1)
(2)
(3)
F27,247
FCAL
F
F
F
F
1.52
24
1.46
31.09
1.46
31.49
Prob
Prob
Prob
1.000
1.000
1.000
0.000
0.000
0.000
Sq.statistic
Source: Authors Calculation
Now, we explain and interpret the results obtained from evaluation of the labor force supply
function reported in Table 3. In all models, the factor of wage is introduced as the key
variable, and other variables including Gross Domestic Product per capita, unemployment
rate, and share of employees of the Agricultural/Industrial/Service sectors are considered as
control variables.
It is revealed from Table 3 that theoretically, the wage rate coefficient is positive, which is
the acceptable sign, and in terms of significance, it expresses an error level equal to five
percent. Therefore, conclusion is 1 percent increase in the real wage rate would bring about a
0.04 percent increase in economic participation. Of course, in obtaining this result, other
conditions are assumed to be constant.
The sign for the variable coefficient of unemployment rate which influences economic
participations obtained as negative for 28 Iran's Provinces. For effectiveness of this variable,
both positive and negative signs theoretically are acceptable. Therefore, negative effect of
this variable represents the effect of discouraging. This problem indicates increase in the rate
and number of unemployment in the society will reduce incentive to find jobs.
In all the approximation models, a positive sign is obtained for the variable coefficient of the
real Gross Domestic Product per capita. This positive sign could indicate the dominance of
the substitution effect as compared to the income effect. The maximum value for coefficient
of this variable is calculated as 8.7 percent. At error levels equal to 5 and 10 percent, this
variable would be defined as significant.
A negative sign is obtained for the coefficient of service sector employees’ share variable
with respect to economic participation. In the previous pages we had stated that in the
countries where agricultural and industrial sectors show a small rate of growth, there is little
inclination for expansion of the service sector (Farjadi, 1999).
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Economic statistics in Iran indicate that the service sector has had a higher growth rate
compared to both other sectors during the period under study. However, examination of the
same statistics reveals that the mentioned growth does not reflect a technological/industrial
growth of the kind that would occur in the developed countries.
The reduction in the share of agricultural sector, combined with the growing increase of
population and transfer of labor force to the industrial sector (when conditions are not
suitable for increasing the agricultural sector’s output), may seem logical. However, due to
the inevitable circumstances brought about by events such as: The Iranian revolution, flight
of domestic and foreign capital, the Iran-Iraq war, economic sanctions, etc., the industrial
sector in Iran has not exhibited enough growth to be able to create enough jobs for the
unemployed who, due to unfavorable conditions in the agricultural sector, have sought
employment in the industrial sector. This condition, in turn, would lead to their being
absorbed by the false service sector as a result of shortcomings including lack of economic
and social infrastructures.
The more people absorbed by the false service sector, the less effective economic
participation in the society is expected. Thus, the spread of the service sector in Iran merely
reflects the persistence of difficulties and restrictions in the Iranian industrial and agricultural
sectors. The sign of the industrial sector employees’ share variable is positive and significant
at 5 percent.
Lewise (1954) believes agriculture to be among the sectors that can be utilized as a great
source by the economic development process for building up an advanced industrial sector
(quoted from Askari, 2004).
Industrial sector employees’ share variable is the only variable that appears with a negative
sign in the model, although this variable; along with the agricultural sector employees’ share
variable, is evaluated as having a positive effect on economic participation rate. This is an
indicative of the dominance of agricultural sector in the studied model.
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Table 3. The estimation results of labor force supply function
Total sample
(1)
(2)
(3)
Variable
coef
t
prob
coef
T
prob
coef
t
prob
C
-1.71
-5.83
0.000
-1.35
-4.15
0.000
-1.66
-5.77
0.000
LWAGE
0.046
3.66
0.000
0.035
2.98
0.003
0.041
3.54
0.000
LUEM
-0.006
-0.27
0.78
0.001
-0.07
0.94
-0.01
-0.526
0.59
LGDPP
0.065
2.42
0.016
0.097
3.64
0.003
0.1
3.76
0.000
LSER
-0.218
-4.56
0.000
-
-
-
-
-
-
LIND
-
-
-
0.138
2.21
0.027
-
-
-
LAGR
Source: Authors Calculation
-
0.228
6.68
0.000
0.187
6.33
0.000
5. Conclusions and Policy Implications
In the present research, different variables including the real wage rate, unemployment rate,
Gross Domestic Product per capita, and employees’ share in the economic sectors of
agriculture, industries, and services were used to investigate the effective factors on the labor
force supply and economic participation. The results obtained lead us to the following
conclusions:
- Income policies are among the factors that influence economic participation rate of
individuals in the society. Appropriate measures by the government and large-scale
policies adopted on the basis of existing economic circumstances in the society, e.g.,
maintaining people’s purchasing power under inflationary conditions, can greatly help
to increase production productivity and consequently, job security, as well as
encourage employers to absorb more labor force and pay higher wages.
-
Since agriculture can be considered as a saving source for macro-investments in Iran,
the government as a large economic establishment in the country should pay
particular attention to the agricultural sector, which is perfectly capable of producing
income as well as creating jobs.
-
The industrial sector, on its own, cannot serve the purpose of creating productive jobs
and income in Iran. Instead, it should play a complementary role alongside the
agricultural sector. In fact, the agricultural sector employs a great labor force, but
according to the Regression Output, increase of labor force beyond a certain threshold
would result in negative productivity and output. This is where the importance of the
industrial sector and the prominent role of the government are revealed in that they
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should make arrangements to gradually absorb this surplus labor force to productive
jobs in the industrial sector. The result would be productive labor force and positive
productivity in the industrial and agricultural sectors, respectively. Upon realization of
such conditions, the number of individuals working in the industrial sector and
consequently productive economic participation in this important sector would start to
increase.
-
The appropriate measures taken by the government for creating productive jobs in
industrial and agricultural sectors would also improve the situation for service sector
employees. By supporting the industrial and agricultural sectors, the government
actually increases the productive job opportunities there and thus prevents entering
inexpert labor force to the service sector. In fact, in order to achieve higher and more
effective economic growth, we should attempt to specialize in the service sector.
In other words, instead of allowing the labor force cast out by the agricultural sector to
the service sector through engaging in petty jobs, i.e., working as peddlers, etc., we
should direct the service sector towards more infrastructural economic activities such as
transportation, communication, educational systems, setting professional training courses,
and more.
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