2016 CFA question

Reform 1: Pension reform which will increase the maximum tax-deductible amount for employee contributions to retirement plans.

Reform 2: A new labor policy for large firms, requiring them to provide mandatory paid childcare leave for all employees.

Determine the most likely effect (decrease or increase) of: i.Reform 1 on growth from capital inputs.

ii.Reform 2 on growth in the actual labor force participation rate.

Reform 1: totally no idea.

Reform 2: I think it should decreases. Without mandatory paid childcare leave, labors may work rather than having childcare leave because they do not get paid. With mandatory paid childcare leave, more labors may choose to have childcare leave because they still get paid, which decreases labor force participation rate. But the answer is increasing.

Have you looked at the guideline answers?

Yes, but still do not understand it.

Reform 1 will lead to higher savings. If I save more, I can invest more in businesses. With higher investments, companies can invest more in physical capital leading to an increase in growth in physical capital.

Reform 2 will lead to an increase in participation rate. The way I see this is if employees are allowed paid leaves to take care of their kids, you would actually see more and more people willing to take up jobs as this option provides them decent balance between worklife and taking care of their kids with no compromise on money.

Couldn’t you argue that because of the paid leave, more people have an incentive to stay home and take care of kids, thus reducing labor force participation?

1 - This should likely increase growth from capital inputs - more savings more capital into the economy

    • This should decrease - labor input lower so productivity might decrease

The answer is : The new labor policy to introduce mandatory paid childcare leave is most likely to _ increase _ growth in the actual labor force participation rate. A larger proportion of the potential working population will remain in the labor force rather than exiting when children are born.

I can’t wrap my head around this.

The way I resonate: If it is easier to get paid leave then more people will remain with current employer and get back once the kid has grown a little. If there would be no paid leave, then perhaps more people would have to quit their current employer as the kid grow, and once that is complete, then they may have to apply for a new job. This mean that there is now a bigger hurdle to go back to work, meaning people fall out from the labor force.