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REGIONAL ECONOMIC ISSUES Working Paper Series Institutional Rigidities as Barriers To Growth: A Regional Perspective Michael Kendix FEDERAL RESERVE BANK OF CHICAGO W P - 1990-6 Institutional Rigidities as Barriers To Growth: A Regional Perspective MichaelKendix The term 'institutional sclerosis' has been used to describe the malady affecting economies suffering from low output growth and an inability to adapt to shocks brought about, for example, by technological change or oil price increases. There are two separate issues here: first, the overall stagnation thathas, at various times, overtaken economies, and second, the sluggish pace of adapting to change. These two problems appear closely relatedsinceregionsoreconomies sufferingfrom one tendtosufferfrom the other. There has been a wide variation in the economic performance of the developed western capitalist economies during the past twenty years. A number ofstudieshave attempted toexplainthis,forexample, by examining thedifferenceinpoliciesusedby governmentsorthedifferencesinthesizeof thepublicsector.1 Although thesefactorsmay beimportant,none canexplain the variation in economic growth or unemployment rates experienced by different regions within the same political boundaries, since these regions experience the same macroeconomic policies and exist under the same politicalandeconomic systems. This paper concentrates on the industrial Midwest and the role of growth retarding institutions therein.2 However, a theory of economic stagnation would be lacking,ifitonly explained events intheone region oftheUnited States. A more impressivetheoryshouldexplainthepresence,orabsence,of economic stagnationinawidevarietyofcircumstances. IftheMidwestcould be shown to be a particular case of a more general pattern of events, this would add considerable weight tothe argument. Therefore, theapproach of thispaperwillbetoexaminedifferencesinregionaleconomicperformancein anumber ofcountries,and thenfocuson theMidwest toseehow itcompares withsimilarregionsindifferentcountries. New Classical vs. Keynesian Approaches to Market Efficiency The most recent mainstream macroeconomic debate has been between the new classical and Keynesian schools. Although both schools have made FRB CHICAGO Working Paper June 1990, WP-1990-6 1 substantialcontributionstoour understanding ofhow economies work, there are some importantphenomena thatthey have been unable toexplain. This section will suggest how institutionalconsiderations are able to fillsome of thesegaps. The roots of the new classical macroeconomics3 are to be found in the classical models, beginning with Adam Smith, continuing through into the TwentiethCentury withAlfredMarshall,and more recentlyMilton Friedman and the monetarists. These schools ofthought have a single,vital,common thread;namely,thatmarketsclear. The logic leading to the market clearingresultissimple butpowerful. The argument reliesan the incentives facing individual market participants. We know from basic microeconomic theory that,ifthemarket price issuch that desiredsalesexceed desiredpurchases, thereisan incentiveforthose sellers who are unable to sell their output to reduce price until the disparity is eliminated. On the other hand, ifdesired purchases exceed desired sales, buyers have an incentivetobidpricesup,again eliminatingthedisparity. In otherwords, atany pricethatdoes notclearthemarket, thereisthepotential formutually beneficialtransactionsthat,ifcarriedout,tendtodrivetheprice towards itsmarket clearing level. Ifthismechanism always operates, there canneverbeanyprotractedperiodofexcesssupplyordemand. The new classicalschoolcannot, therefore,offeraconvincingexplanation of theGreatDepression,orthesecularincreaseintheunemploymentratesofthe developedwesterneconomiesduringthelatterpostwarperiod. Sincethenew classical paradigm denies that long-run disparities between supply and demand can exist, it cannot explain unemployment beyond that due to frictionalfactorsortemporarystructuraldislocation. Anotheromission ofthe new classical theory is itcontains no explanation of consistent, significant differencesineconomic performanceamong regionsofthesame country. For example, as discussed below, during the past twenty years, the level of unemploymentinthenorthandeastUnitedStateshasbeenconsistentlyabove thatofthewestand south. A studyby Hultenand Schwab shows thatwages in the north and east have been above the west and south, but the general direction ofpopulation migration has been to thelatter;thatis,the opposite directiontothatpredictedby thewage differentials. The Keynesian school offers an explanation of protracted periods of unemployed resources, based on long-run market disequilibrium. Authors, such as Barro and Grossman, and Muellbauer and Portes, have laid out FRB CHICAGO Working Paper June 1990, WP-1990-6 2 detailed explanations of the macroeconomic effects of slow or non-clearing markets. The demiseoftheKeynesian schoolinthe1970swas duetoitslack ofconsistentmicroeconomic foundations. Inparticular,thesedisequilibrium theories were able to explain the effects of non-clearing markets, but were unabletoexplainwhy thesemarketsfailedtoclearinthefirstplace. Suppose, for example, that price is set above the market clearing level. Then as discussedabove,thereareunrealizedgainsfrom trade. The questionarisesas towhy suchmutuallybeneficialtradedoesnotoccur. As itturnsout,both thenew classicaland theKeynesian paradigms can make valuable contributionstoexplainingwhy markets do notclear,as well asthe macroeconomic implicationswhen asinglemarketfailstoclear. The former’s insightistorecognize thatthe individual incentives offirms and consumers tend toclearmarkets, butitdoes notexplain why markets do notcleargiven these tendencies. The latter’scontribution isto show how disequilibrium in one market can spill over into others, but provides no explanation of why markets do not clear. That is,the Keynesian model assumesmarkets (or a particularmarket)failtoclear. The Effects of Cartels The internallogicofthenew classicalmodel isirrefutable,butitspredictions arenot always borne out by experience. Therefore, one should examine the underlyingassumptions ofthismodel tofindthesourceoftheproblem. One common assumption of these models is that markets are competitive. However, even if individual firms have monopoly power, this does not explain either why labor markets do not clear or why unemployment varies significantlyovertime within thesame economy. Curiouslyenough, thekey to the answer to these questions lies in the logic of the new classical economics; namely theincentivesfacingindividuals. Ifmarkets do notclear, why do individuals forego the benefits of mutually beneficial exchange? Pursuedtoitsconclusion,thislogicimpliesthatsincethesetransactionsareso compelling, they must have been blocked by forces beyond the control of these individuals. One possibility is that there are incentives for another individual, or group of individuals, to somehow block these transactions. That is,high levels of excess capacity can be explained by the presence of coalitions. These organizationscreatemonopolies, restrictoutput, and block markettransactionsofnon-coalitionmembers. FRB CHICAGO Working Paper June 1990, WP-1990-6 3 One can argue that these types of cartels contain the seeds of their own destruction, due totheoverriding incentive forindividualmembers tocheat. For example, in the case of a cartel of firms, itpays an individual firm to exceed its output quota, regardless of whether its partners adhere to thenquotas. Ifeach firm reactsthisway, thepriceofoutputisdrivenback toits pre-cartel level. Although this incentive is present, there may be stronger forcesbinding cartelmembers together. The theoryofcollectiveaction4 has explained how itispossible for a group to successfully cartelize a market, thereby creating excess capacity. This theory also demonstrates how individual incentives can createprice rigidities, which in turn retardgrowth and reduce an economy's ability to adjust to shocks. Suppose collusive behavior is the source of economic stagnation. Why has this affected the Midwest, and not allregions of the United States? In order to answer this question,itisnecessarytodescribetheprocessofcartelformation. The benefitsofa carteland othertypesofcoalitionshave strongpublicgood characteristics. For example, the members of an industry that lobbies for import protection all receive the benefit of the protection, regardless of whether they contribute to the lobbying effort. Ifa labor union improves writingconditionsinaparticularindustry,allworkersbenefiteven iftheydid notcontributetothestrike,work-to-rule,orwhatevermeans was necessaryto achieve theirgoal. Any self-interested individual would, therefore, sitback and letothersdo thework, then reap therewards themselves. Since no selfinterestedindividualwould evercontributetothistypeofactivity,what isthe mechanism thatallowsthesegroupstoform? The general problem of collusion has been fruitfully examined using the "Prisoners'Dilemma" paradigm.5Inthesituationdescribedabove,forasingle play ofthe'game',theoptimal strategyforallindividualsisnottocontribute tothepublic good, whether ornotanyone elsecontributes. If,however, this game isrepeated many times, that is,itbecomes a 'super-game', the use of sanctions and incentives may result in the cooperative outcome where everyone contributes. For example, during the formative years of labor unions, successful collusion was rarely achieved without actual or threaten violence. Another example isthe OPEC cartel, where Saudi Arabia has on occasion,increaseditsown output,thereby driving down thepriceofoiland punishing other members for previously exceeding their own quotas. Naturally, the Saudis suffer from implementing these sanctions, but other OPEC members' economies may be less able to withstand a shortfall in revenues. The Saudi Arabians might consider these sanctions to be an investment, since inthe long run, they and allthe othercartelmembers will FRB CHICAGO Working Paper June 1990, WP-1990-6 4 benefitifthecooperative solutionisreached. Incentiveshave alsoplayedan important role in binding coalition members together. Common examples include special reductions in costs of goods or services, such as health insurance, vacations and socialactivities. Jointprovisionofthepublic good is,therefore, more likely ifthisgame can be played many times. The time element isof tantamount importance because, despite theirpervasiveness in many economies, exclusive cartels and other rent seeking coalitions do not formeasily. In the initial stages of collective action these groups encounter great difficulties. Aside from theconflictingintereststhatmay ariseamong cartel members, thecartelmay havetobattle(sometimesliterally)forcesoutsidethe cartel, whose interests are compromised by the cartel's presence. For example, thehistoryoftheBritishlabormovement isfilledwith examples of failure and breakdown of workers' organizations.6 Certain factors may facilitatecollusion, such as member homogeneity and small group size,but unusual circumstances may have to occur before a coalition is successful. One example of unusual circumstances is the emergence of extraordinary leaders with the ability to organize and motivate their members. Ideal conditions forcollusion seldom arise,but the longer theperiod ofeconomic and politicalstability,7 thegreateristheprobability thatthecoincidental set ofcircumstances requiredforsuccessfulcollusionwilloccur. Consequently, onewouldexpectmore ofthesetypesofcartelsinregionsthatareolder,since colluderswould have had more time toorganize,arrange incentives fortheir members andpunishfree-ridersby metingoutsanctions. In general, cartels seek to reduce output so their members can acquire monopoly rents. Therefore, thepresence ofa cartel tends toraisepriceand reduce output, below that which would have occurred in its absence. Consequently, ifan economy contains large numbers of these cartels, there will be a significantlossofoutput. Besides forming cartels,thereare other ways toacquirerents,forexample, legislationproviding groups with special tax breaks or government subsidies. Tax breaks and subsidies also tend to distortprices,resultinginan inefficientallocationofresources. Itispossible that this type of collective action could move a market closer to its most efficientoutput. However, thisislikelytooccurmore by chancethandesign, since the overriding objective of a group is to divert resources toward themselves. Usually,collectiveactionofthisnaturebenefitsthemembers ofthegroup,at the expense of a loss in efficiency for the societyas a whole. The adverse FRB CHICAGO Working Paper June 1990, WP-1990-6 5 effectsofasingleinterestgroupupon theentireeconomy mightgo unnoticed, becausetheburdenissharedby suchalargenumberofpeople. Therefore,the presence of a few rent seeking groups is unlikely to significantly reduce output forthe whole economy. However, given time and a stableeconomic andpoliticalenvironment,thesegroupsmay become ubiquitous,resultingina substantial loss of output. The benefit to each individual member of the coalitionmust,ofcourse,exceedthecosttoasingleindividualoutsideofthe group. Ifthiswere not true,itwould notbe intheinterestofindividuals to collude, since they would lose more as members of the society as a whole, than they would gain as members of the interestgroup. In summary, these types ofexclusive groups directresources toward themselves, but ata cost; namely,areductioninoutputfortheeconomy asawhole. The abovedescribeshow exclusiveinterestgroupsreduceoutput. Itturnsout thatthepresenceofthesegroupscanalsoexplaintheinabilityofeconomies to adjust to adverse shocks. Collective action, of the kind discussed above, requires a concerted course ofaction, and the members ofa cartelor lobby group must arrive at a consensus concerning the means of acquiring and dividingtheirmonopoly rents. Thisprocessisexpeditedifthegroupissmall andhomogeneous. Forexample,inBritain,asdiscussedby Olson (1965),the earliestindustrialunions comprised skilledworkers who were few innumber and who oftenmet inpubstodiscussunionbusiness. Similarly,intheUnited States,workers were firstorganizedinsmallcraftindustries. However, even witharelativelysmallmembership thereisalways theproblemofreachingan agreementamong thecartelmembers. Thismeans thatan industrycartelora special interest lobby group must spend some time before they arrive at a consensus. For example, ifa cartel'smarket conditionschange unexpectedly, thecartelwillhavetoadjustitspriceandoutputtoachieveitsobjectives.This requiresthemembershiptoreachanew consensusonpriceandrentdivision. The cartel must, therefore, decide upon the optimal means to make such a decision. This problem has been examined by Buchanan and Tullock, who dividethecostsofcollectivedecisionmaking into'time'or'decisionmaking' costs,and 'external'or'dictatorial'costs. The timecostsareduetointra-cartel bargaining; forexample, ifthecartelinsistsupon unanimity,thesecostsmay be prohibitively high. On the other hand, ifthe cartel uses the method of majority decision, the majority might impose 'dictatorial' costs upon those members in the minority. At one extreme, an interestgroup cannot use the unanimity rule because the cartel may fail to reach a decision within a reasonabletime,butitmay need more thantheagreementoffifty-onepercent of itsmembers, otherwise there isthe danger of large number of members FRB CHICAGO Working Paper June 1990, WP-1990-6 6 refusingtocooperate. The most likelyoutcome isthatthecartelwillchoose decisionrules thatfallsomewhere between these two extremes; forexample, they may require the consent of two-thirds of the membership before any changescanoccur. Consequently,thereiscertaintobeatimelagbetween the initialchangeinmarketconditions,andtheeventualchangeincartelpriceand output. Aside from various voting rules,thereareotherproceduralrulesdesigned to reduce time spent on intra-cartel bargaining and decision making. For example,asdiscussedby Olson (1982),fixingprice,ratherthansettingoutput quotas, may be used toexpediterentdivision. The ideaisthathaving seta price,rentdivisionislefttothemarket,which isperceivedasanarbitrary,but fair,determinantofrentallocation. As aprerequisiteforsuccessfulcollusion, notonly must each member of the group participateinproviding thepublic good, but each member has to be assured thateveryone else is doing their share. Ifnot,thecooperativearrangementmay eithernot emerge inthefirst place or may break down. Another advantage, therefore, of fixing prices ratherthanquantities,istheformerfacilitatesmutualobservation. Even withestablishedproceduresthatshortenthetimespentmakingdecisions about price and rent division, the need for consensual decision making requiresthegroup tospend some time making a decision. These intra-cartel time bargaining costs may discourage a cartel from making any changes in output price, unless the prospective gains from adjusting theprice outweigh these bargaining costs. For example, a cartel will adjust its price only if market conditions have deviated substantially from the cartel’sexpectations, formedwhen thepricewas previouslynegotiated. In summary, these types of cartels, not only tend to reduce output for the economy as a whole, but also tend to fix prices as part of their decision expediting procedures. In contrast to the Keynesian model, the collective actionmodel doesnotassume thatpricerigiditiesexist,butdemonstrateshow they arise from the self-interested behavior of individuals engaged in rentseeking activities,through cartelization ofmarkets. Ifthe proportion of the economy coveredby thesecartelsand interestgroups isrelativelysmall,their effect on the ability of the economy to adapt to adverse shocks will be accordingly diminished. If a country or region has enjoyed a protracted periodofstability,however, largenumbers ofthese coalitionsmay have had the opportunity to form. In this case, they may be pervasive and have a considerableimpactonaneconomy’sadaptabilitytoshocks. FRB CHICAGO Working Paper June 1990, WP-1990-6 7 Regional Disparities of Growth The plausibilityofthecollectiveactionmodel canbe increased,ifitisshown to apply in many different situations. To this end, some preliminary descriptive datahave been collectedon Britain,Canada and West Germany, as well as the United States. Although the evidence presented for some countries isnotas detailedorrigorous as fortheUnited States (presented in more detail laterin the paper), the results are stillinteresting since they all point in the same direction; that is,the older regions of economies tend to exhibitslower growth, and sufferdeeperrecessionsthan lessmature regions. Ideally,one would liketolook atoutputand growth ratestotesttheinterest group hypotheses. Unfortunately, thesemeasures arenotreadilyavailablein allcases. Nevertheless, asidefrom outputdata,thereareotherindicationsof regional prosperity and growth. Inparticular,thisstudy willconcentrate on the labor market. Although this is only a single market, itspervasiveness makes itworthyofinvestigation. ConsiderTables 1through 4,depictingregionaloutput, employment growth, and unemployment rates for various time intervals. In the case of West Germany (Table 1),the older industrialregions tend to be in the north and west, forexample, Bremen, Hamburg, Niedersachsen, Nordrhein Westfalen, and Saarland. The areas with more recent industrialdevelopment are in the southand includeBaden-Wurttemberg andBayern. The dataforGDP growth in Table 1 show that the newer regions have clearly outstripped the older regions. The fourthcolumnexplicitlyshows thedecliningrelativeimportance of the older regions. The population and labor market data show similar trends. For example, despitean annual increaseofone-thirdpercentinWest Germany's total population between 1961 and 1986, the populations of Bremen, Hamburg, and Saarlandhaveactuallyfallen. The otherolderregions have also had below average population growth. The regions of greatest population increase have been in the south, for example, in BadenWurttemberg and Bayern. The labor market data also show the most vital regions tobe in the south. For example, employment growth between 1976 and 1987 inBayern was nearly threetimes thenationalaverage. During the same period, employment eithercontracted or remained below the national average in allthe older regions. The unemployment data present a similar picture,with thehighestratesintheolder,northernregionsand thelowestin thesouth. FRB CHICAGO Working Paper June 1990, WP-1990-6 8 Table 1 West Germany: Output, Population and Employment Annual % GDP Growth 1960-87 Schleswig-Holstein Hamburg Niedersachsen Bremen Nordrhein-Westfalen Hessen Rhineland-Pfalz Baden-Wurttenberg Bayern Saarland Berlin West Germany 3.7 2.8 3.2 2.6 3.0 4.1 3.8 4.0 4.2 2.9 3.3 3.5 Annual population growth 1961-86 Schleswig-Holstein Hamburg Niedersachsen Bremen Nordrhein-Westfalen Hessen Rhineland-Pfalz Baden-Wurttenberg Bayern Saarland Berlin West Germany 0.49 -0.54 0.32 -0.27 0.18 0.58 0.22 0.76 0.60 -0.10 -0.57 0.33 FRB CHICAGO Working Paper June 1990, WP-1990-6 Annual employment growth 1976-87 0.69 -0.54 0.33 -0.71 -0.14 0.58 0.57 0.77 1.18 -0.25 0.01 0.40 % of Total GDP 1960 % of Total GDP 1987 3.31 5.36 10.57 1.71 30.10 8.72 5.04 14.20 15.18 1.78 4.04 100.00 3.46 4.50 9.69 1.37 26.24 10.02 5.37 16.11 17.95 1.50 3.78 100.00 Difference in % of Total 1960-87 0.16 -0.86 -0.88 -0.35 -3.86 1.31 0.33 1.91 2.77 -0.28 -0.26 100.00 Average unemployment rate 1971-80 Average unemployment rate 1981-88 Average unemployment rate 1971-88 3.6 2.7 3.9 3.9 3.5 2.7 3.2 2.0 3.3 4.9 3.0 3.1 9.9 10.4 10.7 12.9 9.9 6.6 7.8 5.0 7.0 11.7 9.4 8.3 6.2 5.8 6.7 7.6 6.1 4.3 5.1 3.2 4.8 7.7 5.7 5.3 9 Table2 showsregionaldataforBritain,thefirstcountrytoindustrialize. The industrialheartland of lateEighteenth and early Nineteenth Century Britain was in the North West, which contained the cotton industry, Yorkshire & Humberside,home ofthewoolindustry,theNorth,Wales and Scotland,allof which contained large coal deposits. Regional output data are not readily availableforBritain, however, the labor market trends allshow therelative economic stagnation of the older regions. Between 1972 and 1987, employmentinBritaincontractedatan annualrateof0.07percent. The only regions where employment growth was positive were in the south, the east, andpartoftheMidlands; namely intheSouth East (which includesLondon), the South West, East Anglia and the East Midlands. Unemployment rates between 1965 and 1988 were also significantly greaterin the older regions. All the older regions had unemployment rates above the national average. Thiswasthecasebothduringandaftertheoilpricerisesof1973 and 1979. Table 3 shows labor market data forthe ten Canadian provinces. As isthe casefortheUnited States,thenewer regionslietothewest and theyare the regions of highest employment growth. For example, theprairieprovinces andBritishColumbia. The lowestunemploymentratesarealsotobe foundin these regions. The older regions, for example, Quebec and the maritime provinces (exceptPrinceEdward Island) tend tohave higher unemployment ratesandloweremploymentgrowth. Table 4 shows similar labor market data for the nine census regions of the United States. The lowest rates of employment growth are for the MidAtlanticandEast-North-Centralregions. Theseoldindustrialregionsalsohad unemploymentratesabovethenationalaveragebetween 1964 and 1988. The East-North-Centralregion also sufferedthe most during the recession ofthe early nineteen-eighties. In summary, therefore, although the industrial Midwest oftheUnited Statesdiffersfrom theoldindustrialregions ofWest Germany, Britain,andCanada inmany ways,itsrelativeeconomic prosperity matchesthepatternoftheolderregionsintheseothercountries. In addition to explaining differences in regional performance at particular pointsintime,thecollectiveactionparadigm isalsoabletoexplaintheslow growth and slow adaptabilityofolderregionsand countriesacross time. For example, the relative decline of Britain since the middle of the Nineteenth Century. In 1800, Britainproduced approximately 90 percentoftheworld's coal outputand somewhat lessthan halfofthecombined Continentaloutput of iron. Between 1830 and 1850, Britain'soutput of ironrose from 680 to 2250thousandtons,andheroutputofcoalrosefrom 15to49 milliontons. FRB CHICAGO Working Paper June 1990, WP-1990-6 10 Table 2 Britain: Employment and Unemployment Average annual percent change in employment North Yorkshire & Humberside East Midlands East Anglia South East South West West Midlands North West Wales Scotland Great Britain 1972-80 1981-87 1972-87 0.03 0.33 1.00 1.73 0.38 1.29 0.01 -0.10 0.49 0.46 0.41 -1.41 -1.25 -0.07 1.82 -0.02 -0.05 -0.94 -2.08 -2.07 -1.38 -0.69 -0.60 -0.36 0.53 1.77 0.21 0.70 -0.41 -0.97 -0.63 -0.35 -0.07 Average annual unemployment rate 1965-88 North Yorkshire & Humberside East Midlands East Anglia South East South West West Midlands North West Wales Scotland Great Britain FRB CHICAGO Working Paper June 1990, WP-1990-6 7.7 5.7 4.6 4.1 3.7 4.9 5.7 6.7 7.0 7.1 5.2 1965-73 4.3 2.5 1.9 2.0 1.5 2.5 1.9 2.7 3.7 4.1 2.1 1974-80 5.5 3.8 3.3 3.2 2.6 4.0 3.8 5.0 5.1 5.2 3.8 1981-88 13.6 11.0 8.9 7.2 7.0 8.2 11.6 12.7 12.4 12.1 9.7 11 Table 3 Canada: Employment and Unemployment Average annual percent growth in employment Newfoundland Prince Edward Island Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Canada 1976-83 1976-81 1982-83 1.68 3.92 1.13 1.32 1.07 1.73 1.39 3.06 4.47 2.42 1.87 2.98 5.76 1.65 2.22 1.92 2.61 1.85 3.61 6.52 4.19 2.91 -2.33 -1.60 -0.42 -1.35 -1.48 -0.89 0.01 1.41 -1.66 -2.89 -1.25 Average annual unemployment rate Newfoundland Prince Edward Island Nova Scotia New Brunswick Quebec Ontario Manitoba Saskatchewan Alberta British Columbia Canada FRB CHICAGO Working Paper June 1990, WP-1990-6 1966-83 1966-73 1974-83 13.1 8.6 8.4 10.0 8.8 5.5 4.9 3.9 4.3 7.6 6.8 10.4 6.5 6.2 7.8 6.9 3.8 3.6 3.1 3.5 6.2 5.2 15.3 10.2 10.1 11.8 10.3 6.9 5.9 4.5 5.0 8.7 8.1 12 Table 4 United States: Employment and Unemployment Average annual percent change in non-agricultural unemployment rate 1965-88 New England Mid-Atlantic East-North-Central West-North-Central South Atlantic East-South-Central West-South Central Mountain Pacific 48 contiguous states 1.7 1.1 1.5 2.0 3.3 2.5 2.9 3.8 3.2 2.2 1965-73 2.2 1.4 1.7 2.3 3.8 2.8 3.3 3.9 3.3 2.5 1974-80 2.2 1.8 2.7 3.0 4.9 4.0 4.1 4.7 3.5 3.2 1981-88 2.2 1.1 1.1 1.8 3.1 2.0 2.8 3.4 3.1 2.1 Average annual unemployment rate 1964-88 New England Mid-Atlantic East-North-Central West-North-Central South Atlantic East-South-Central West-South Central Mountain Pacific U.S. FRB CHICAGO Working Paper June 1990, WP-1990-6 5.7 6.4 6.6 4.7 5.5 6.6 2.9 5.5 7.1 6.2 1964-73 5.0 4.7 4.2 3.5 3.9 4.4 3.3 4.2 6.1 4.6 1974-88 1980-88 6.1 7.5 8.2 5.5 6.5 8.2 4.1 6.5 7.8 7.2 6.0 8.1 10.3 6.7 7.2 2.0 10.0 6.8 8.5 8.1 13 Thatis,averageannual growthrateofover6 percent. Incontrast,during the post-war era, Britain’sgrowth rate has been the lowest of the industrialized economies. Britain has enjoyed the longest period of stability, and in this senseitistheoldesteconomy ofallthewestern developed economies. The collective action model also explains the economic emergence of 'newer' economies, such as South Korea and Taiwan. These countries have experiencedrecentupheavals(duringWorld War Two), thathave sweptaway growthretardinginstitutions. Consequently, theseeconomies shouldbemore vibrantsincetheyhavenothadsufficienttimetoacquirerent-seekinggroups. Labor Unions as Special Interest Groups There aremany examples ofrent-seeking interestgroups, some ofwhom are more obvious thanothers. Forexample, organizationsthatrepresentspecific industries, such as agriculture, railroads, steel, and various manufacturing industries,lobby legislaturesforspecialtaxconcessions,importprotectionor subsidies. There arealso lessobvious groups, forexample, tradeguilds and professional organizations thatoversee standards ofproduction and monitor (orrestrict)industryentrants,suchasthevariousprofessionalorganizationsof physicians,lawyers,and accountants. Many oftheseorganizationsoperateto improve the quality of production and services, but their activities (intentionallyor not)often limitindustryoutputand restricttheflow ofnew entrantsintotheindustry. A more obvious rent-seeking type oforganization isthe labor union. Since thecollectiveactionhypothesispredictsthatolderregionscontain more rentseeking groups ingeneral, thisimplies inparticulartolaborunions. Indeed, thedatainTables 1through4 suggestthatadetailedexaminationofthelabor market would provide a useful testofthe collective action hypothesis. The hypothesis predicts first,thatcartelized markets tend to have greater excess capacity. This implies thatthe most heavily unionized regions are likely to have low employment growth and higher unemployment. The second predictionofdie model, namely thatcartelsare slow toadjusttochanges in market conditions,hasramificationsfortheway recessionsandbooms affect cartelized labor markets. This latterhypothesis isworthy of more detailed explanation. First, it is necessary to characterize the kind of labor union under consideration. A laborunionisassumed tocompriseagroup ofworkers that colludewith theobjectiveofraisingtheirwages; thatis,theymonopolize the FRB CHICAGO Working Paper June 1990, WP-1990-6 14 labormarket The union’sdecisionsaremade according toa utilityfunction containing theunionwage and thequantityofemployment asgoods’. In this ’monopoly union’paradigm, theunion must choose itsmost favoredpointon the l abordemand curve, just as a monopoly firm chooses the profit maximizing pointon itsmarket demand curve. The union, ineffect,facesa trade-off between wages and employment, in a similar way to consumers choosing between two or more goods; that is, a union can choose higher wagesorhigheremployment,butnotboth. Consideraunionizedlabormarket thatfacesa sudden change inthedemand forlabor. In a competitive labormarket, (under the most usual assumptions abouttheslopesofthedemand and supply oflaborschedules)both thewage and employment willadjustuntiltheexcess demand or supply iseliminated. Ina unionizedlabormarket, however, theunion must decideon a new wage andemploymentlevel,giventhechangeinlabormarketconditions. As discussed above, considerable time may elapse before a cartel isable to reach an agreement about the wage and rent division. In the case of labor unions, rents only accrue to those remaining in employment. Therefore, if there has been a decrease in labor demand, the rent division decision is equivalent to deciding which members, ifany, should become unemployed. A number ofoptionsareavailabletotheunioninthisrespect. Forexample,it ispossiblefortheunion toreduce every member's hours ofemployment by thesame amount; thatis,puteveryone on short-time. Usually, however, the totalhours ofemployment are reduced (atleastpartially) by allowing some members to be made unemployed.8 For example, the seniority criterion is often used as a determinant of which members remain in full-time employment. According to Oswald (1984), "...this rule is apparently ubiquitous in the U.S. industrial union sector;...". This rule is another example of a predetermined procedure, designed to reduce intra-cartel bargaining costs and speed up the cartel's decision-making process.9 However, even with these time-reducing procedures, there may be a significant lag between the change in labor market conditions and wage adjustment. Given thatcartels,including laborunions, tend tosetprices (or wages), theburdenofadjustmentincartelizedmarkets willbe on quantity,or inthecaseofthelabormarket,employment. Considernexttheeffectofan unanticipateddecreaseinthedemand forlabor. Inacompetitivelabormarket,thewage isbiddown andemploymentfalls. In a unionized setting, slow decision making allows the wage to change only after a time lag, and employment bears the whole burden of adjustment. FRB CHICAGO Working Paper June 1990, WP-1990-6 15 Thus, slow decision making in cartelized labor markets tends to exacerbate the unemployment that generally accompanies a recession. Conversely, following an increase in labor demand, an inflexible-wage leads to a larger rise in employment than under competitive labor market conditions. Therefore, slow moving cartelstendtocreatelessexcess capacity ina boom periodbecause slow wage adjustment exaggerates the beneficial effectsof a boom onemployment. Models withincompletepriceadjustment,thatgeneratechanges inoutputand employment, havebeenapartoftheeconomic literatureforsome time. Price rigiditiescan arisefrom sources other than cartels,forexample, incomplete information about markets,10 the costs of gathering information11 or imperfect competition.12 However, unlike the collective action model, these theories do not explain why price rigidities should be pervasive in mature regionsandeconomies. Recently, there have been contributions that have built upon the collective action hypothesis and provided a more detailed examination of cartelized labormarkets. One ofthe most important, forthepurposes ofthispaper, is the work done an 'insider-outsider' and 'hysteresis'13 theories of unemployment.14 These theories concentrate an therole oflabor unions as monopoly cartels,and show how unionscangenerateexacerbatedfluctuations in employment (and hence unemployment) without assuming wage inflexibility. The term 'insider-outsider' conveys the idea of one group excludinganother,which isespeciallyappropriateinthepresentcontext. The 'insiders'are the group of labor union members and the 'outsiders'are those workers seekingemployment. The insider-outsidermodel assumes first,that the union leadership only considers the welfare oftheirown members when making a decision about wages and employment. Second, a worker's membershipdependsupon theirbeingcurrentlyemployed (oratleastrecently employed). These two assumptions are fairly standard and are part of previous contributions to the monopoly union literature.15 The key extra assumption of the insider-outsider model emanates from the idea that the union onlycaresaboutitsown members. Given this,they assume thatwhen there are fewer members, the union sets employment lower than otherwise. The corollaryofthis,isthatsincetheunionisconstrainedtothelabormarket demand curve,itwillchooseahigherwage when thereisasmallernumber of unionmembers. Given these assumptions, suppose there isan unexpected reduction in labor demand. Ifthe union considers the 'wage' and 'employment' to be normal FRB CHICAGO Working Paper June 1990, WP-1990-6 16 goods,bothofthesewilldecreasefollowingthisdeteriorationinlabormarket conditions. However, since membership is contingent upon recent employment, and employment has fallen, the union has fewer members to worry about. Therefore, in future periods, when membership islower, the union will negotiate a higher wage and lower level of employment than otherwise. In brief, any decrease in labor demand that leads to a fall in employment (and a riseinunemployment) isexacerbated due tothe inverse relationbetween theunion’schoiceofwage andthequantityofmembers. On theotherhand, ifthereisan increaseinlabordemand, thereisno reason for the union to allow employment to rise by letting outsiders enter the labor market. In themonopoly union model, iftheunion increasesemployment, it would have totemper thewage increasesofexistingmembers. Therefore,in an insider-outsidermodel withoutwage stickiness,employment eitherfallsor remainsunchanged.14 Sincethecollectiveactionmodel hasaconvincingexplanationofwhy cartels' prices (or wages) should be sticky, and we do observe increases in employment in unionized industries,thenext step should be tocombine the insider-outsiderand collectiveaction models. Let us assume, therefore, that first, there is an inverse relation between the union’s wage choice and the number ofmembers and second,thatunions adjustwages onlyafteralag. In describing a union's reaction to a change in labor demand, itis helpful to dividethesequence ofeventsintothreetimeperiods. Inthefirstperiod,the union isininitialequilibrium. Inthesecond period,theimmediate effectsof the change in labor demand take place. In the third period, the new equilibrium levels of wages and employment are established. In order to simplify matters, we will assume that membership in the current period is contingentuponemploymentintheprecedingperiod. Suppose there is an unexpected decrease in labor demand. In the second period,sincetheunionisaslowdecisionmaker,thewage isstuckatitsinitial leveland employment bears the totalburden ofadjustment. Inperiod three, membership declinesbecauseemployment hasfalleninperiodtwo. Although thedeteriorationinlabormarketconditionstendstodecreasetheunion'swage choice, the decrease will be mitigated because the number of members has fallen, which tends to raise the union’s wage. The sequence of events following an unexpected increase in labor demand are the reverse of the above. Inthiscase,thewage isstuckinperiodtwo andemploymentrises. In thethirdperiod,thenumber ofmembers risessinceemployment hasrisenin period two. Although the union tends to choose a higher wage due to the increase in labor demand, this increase is offset, at least in part, by the FRB CHICAGO Working Paper June 1990, WP-1990-6 17 increaseinmembers, which tendstoreducetheunion'schoiceofwage. Thus, combiningtheslowdecisionmakingresultofthecollectiveactionmodel with thetypeof'selfish'behavioroftheinsider-outsidermodel,leadstoevenwider swingsinemploymentandhenceunemployment. Evidence of Unions' Effects on Unemployment Therearetwo hypothesespresentedinthepreceding discussionregardingthe regional effectsoflaborcartels. First,thatlaborcartelstend toraisewages, reduceemploymentandraiseunemployment. Second,thattheunemployment generatingeffectsoflaborcartelsareincreasedduring nationwide recessions and mitigatedduringnationwidebooms. That is,laborunionsexacerbatethe swings in unemployment over the course of the business cycle. The first hypothesiscan be testedby simply looking attherelationshipbetween union presence and unemployment rates. Below are presented the results of an ordinaryleastsquaresestimation,usingdataforthe48 contiguousstates. The measure used to approximate union presence isunion density (UD), thatis, the percent of non-agricultural employees that are union members. The collective action hypothesis, that cartels create excess capacity, would be supported if the coefficient on the union density variable is large and significant. Intheseregressions,an effortwas made toaccountforthepossibilitythatthe apparent relation between union density and unemployment was caused indirectlyby athird,more importantvariable. First,ithasbeen suggestedthat unions tend to be prevalent in industries with a high degree of industryspecific human capital. Ifthis istrue,following a deterioration in business conditions,therewould be atendency tohave more temporary lay-offsrather than redundancies. This would benefit firms who would be able to recall more productive workers when conditionsimproved. Workers would be less willingtoseek employment elsewhere because oftheincentive towait fora recall and realize the benefits of their specific human capital. The extra unemployment generated by this arrangement would not be due to the monopoly effectsofunions,butmightbe theoutcome ofan efficientimplicit (or explicit) contract between a firm and its employees. It is possible, therefore, that the observed relationship between unemployment and union densityisdue tohuman capitaleffects,ratherthanthemonopoly unioneffects discussed earlier. Second, according to the collective action hypothesis, the oldestindustriesaremore likelytobeunionized. Itispossiblethattheseolder industriesareinthefinalstageoftheirproductcycle. Theiremploymentmay FRB CHICAGO Working Paper June 1990, WP-1990-6 18 be declining and their unemployment rate higher than other industries, for example, due totechnological change. The expected rateofunemployment, giventheindustrialstructureofaregion,isequalto 1) IMrt= ZEMjrtUNjt . j IMjtistheindustrialmix ofregionrattimet. EMjrt isthepercentofworkers employed in the j-th industry, in the r-th region at time t. UNjt is the unemploymentrateforthej-thindustryattimet. A secondcontrolvariableinthemodelwas thelevelofeducationalattainment (ED),measuredasthepercentofthelaborforceovertwenty-fivewithatleast twelve years of formal education. This was used to control forlabor force quality,sinceaworkerwithsome educationwouldhavelessdifficultyshould hebecome unemployedandwouldbemore likelytofindajobmatch. Third, an oilemployment variable (OIL) was used tocontrol forthe special labormarketconditionsinsomeregionsoftheUnitedStates,createdby world oilprice movements. This variable isthe percentofemployment in the oil industrymultipliedby thepercentchangeintherealpriceofoil. Fourth, a measure of states'unemployment insurance benefitgenerosity was included intheregressions. The measure used here was theaverage weekly benefitdividedby theaverageweekly wage inmanufacturing(RR). Thiswas used to account forthe possibility thathigh benefits encourage unemployed workers to remain idle. Higher benefits may also encourage unemployed workers to search longer for a new job, rather than take the firstjob that comes their way. This raises the average duration of unemployment and hencetheunemploymentrate. The datausedwerefrom 1964 to 1985,pooled overthe48 contiguousstates. Theresultsofordinaryleastsquaresestimation were: 2) UN = -1.37 + .054UD + .754IM + .008ED - 4.05RR + .0010IL, R2 =.43 (2.44) (8.24) (23.4) (1.30) (3.30) (1.05) The numbers in parentheses are the absolute value of the t-statistics. The union density variable is highly significant and its coefficient suggests an increaseinuniondensity,sayfrom 10to20 percent,raisestheunemployment rate by about half a percentage point. This number may not appear particularlylarge,butinthestateofIllinoisthiswouldhave amounted toover FRB CHICAGO Working Paper June 1990, WP-1990-6 19 31,000 jobsin 1988. However, thisequationestimatesan averageeffectover aperiodof22 years. The secondresultofthecollectiveactionmodel predicts thatthiseffectvariesaccordingtothenationalconditionofthelabormarket. As a simple testofthissecond hypothesis, the same equation was estimated for each of the 22 years in the sample, again using data from the 48 contiguousstates. Fortunately,forthepurpose ofthisanalysis,thetime span contains spells ofboth, very high and fairlymodest national unemployment rates. Itis,therefore,possibletoexamine theeffectsofunionpresenceon the unemployment rate over a broad spectrum of labor market conditions. For example,thisperiodincludesthemiddleand late1960s,when unemployment was extremely low. Italso includes the recessionsbrought about by the oil price rises of 1973 and 1979. The theory predicts that the coefficient estimateson uniondensityshouldbeespeciallylargeandsignificantwhen the national unemployment rate is high, and conversely when national unemploymentislow. The resultsoftheseestimationsaresummarized inFigure 1,and arestrongly supportive of the hypothesis that unions have a far greater tendency to generate excess capacity in the labor market when national labor market conditionsarepoor. Figure 1plotstheestimatedcoefficienton uniondensity, againsttheUnited States unemployment rate,between 1964 and 1985. The collinearityoftheseseriesisstartling. The coefficientpicksup theperiodsof highunemploymentduringtheearlyseventies,themid-seventiesandtheearly eighties. Italsofollowsthelow unemploymentperiodsofthelatesixtiesand late seventies. When the national unemployment rate is low, there isvery little,ifany effectofunions on unemployment. For example, in 1968 when the United States' unemployment was below 4 percent, the estimated coefficienton union densitywas only .03,implyingthata 10percentincrease inuniondensity,raisesastate'sunemploymentrateby lessthanone thirdofa percent. However, in 1983 when thenationalunemploymentratewas almost 10 percent, the estimated coefficient is .25. This implies thata 10 percent increaseinuniondensityraisestheunemployment rateby 2.5percent,which inthestateofIllinoiswouldhaveamountedtoabout 150,000jobsin1983. Data on laborunionsintheUnited Statesstronglysupportthehypothesisthat rent-seeking organizations worsen the effect of a recession. On average, between 1964 and 1980, the statescomprising theindustrialMidwest region allrank in the top ten most heavily unionized states.17 Itisnot surprising, therefore,thatthisregionwas thehardesthit,interms ofunemployment (see Table4),duringtherecessionoftheearly 1980s. FRB CHICAGO Working Paper June 1990, WP-1990-6 20 Figure 1 UD coefficient and % US unemployment rate percent In summary, both the hypotheses of the collective action model are well supported by regional United States data. More exhaustive and detailed analyses has been completed using other sets of regional data. Standard Metropolitan StatisticalArea (SMSA) datafor 34 citiesin theUnited States has yielded strong results in favor of the collective action model. Similar robustresults have been found, using regional dataforBritain.18As can be seen inTable 2,theolderregions sufferedconsiderably during therecession oftheearly 1980s,and theseareby farthemost heavilyunionizedregionsin Britain. The overallevidence suggests,therefore,thatthepatternsofrelative prosperity and excess capacity in the industrial Midwest have also been observedinothercountries1olderregions. FRB CHICAGO Working Paper June 1990, WP-1990-6 21 Implications for the Future What are the prospects for the older regions and countries? Are they perpetuallyconfinedtoapathofslow growth? Willtheyalwaysbe subjectto severe recessions, brought on by supply and demand shocks? In particular, whataretheprospectsfortheindustrialMidwest inthiscontext?Thereareno straightforwardanswerstothesequestions. The finalpartofthispapertriesto evaluatefirst,whether theMidwest has improved itsgrowth potentialand its economic resilience. Second, whether the position of the Midwest in this respecthasimprovedrelativetotheotherregionsoftheUnitedStates. The recessionsofthe 1970sandearly 1980shave ledtoashake-outincertain industriesand,accordingtothecollectiveactiontheory,theheavilyunionized industries are the most vulnerable to downturns in economic activity. Consequently, a region's labor force should comprise proportionately fewer laborunion members aftera severe recession. This hasbeen thecase in the United States as a whole, where union density fell from 26 to 17 percent between 1973 and 1988.19 Unfortunately, it is not possible to say with certaintyhow theseeffectshave been distributedregionally,because data on regionaluniondensityarenotavailableafter1982. Itispossible,however, to gathersome information on thedirectionofunion densityintheMidwest by lookingattheregion'sindustrialstructure. The data in Table 5 show the annual percent change in employment by industry forthenine Census regions of theUnited Statesbetween 1973 and 1988. The formeryearwas chosenbecauseitprecedestherecessionresulting from the first oil price shock. During this period, employment in the industrialMidwest regiongrew by abouthalfthenationalaverage. The most heavily unionized sectors, namely, mining, construction, manufacturing and transportation,20grew atamuch slowerrateintheMidwest regioncompared with thenationaltrend. Inparticular,manufacturing employment contracted atfive times the national average rate, falling from one third to less than a quarter of the region's total employment. The biggest growth sector in the region was services, where union density is typically low. These trends suggest that union density in the Midwest region has fallen. The shifts in Midwest employment by sectorand theirrelativeimportancearedisplayedin Figure 2, which shows the number of jobs that were lost relative to the national trend. For example, ifmanufacturing employment in the Midwest region had only contracted at the same rate as the remainder of the United States,therewould havebeenover 1.1millionmore manufacturingjobsinthe FRB CHICAGO Working Paper June 1990, WP-1990-6 22 region. The graph indicates that the biggest effect in private sector employment was in the manufacturing sector. However, thegrowth ratesof thewholesaleandretailtradeand servicesectors,bothofwhich contain very low proportions of union members, were below the national average. In contrasttotheeffectfrom themanufacturingsector,thiseffectwould tendto increase union density in the Midwest region relative to other regions. Therefore, while the Midwest has probably losta large percentage of union workers, there is some doubt as to whether the loss has been above the nationaltrend. T a b le 5 Percent change in em ploym ent by sector, 1973-1988 min New England Mid-Atlantic East-North-Central West-North-Central South Atlantic East-South-Central West-South-Central Mountain Pacific U.S. 10.0 -2.0 -0.7 -1.2 -1.3 0.8 2.5 0.0 2.1 0.7 con______man tran W&R -0.3 -2.0 -1.5 0.3 0.6 0.1 0.9 2.5 1.7 -0.3 1.0 -0.1 0.3 0.9 2.1 1.9 1.8 2.8 1.6 1.1 2.9 1.6 1.9 2.1 4.0 2.9 3.0 3.6 3.5 2.7 2.5 1.3 0.5 0.5 1.7 0.4 0.4 0.8 3.5 1.4 fin 3.8 2.4 2.7 2.9 4.1 2.9 3.8 4.3 4.2 3.3 ser 4.5 3.6 3.7 3.9 5.8 4.2 4.9 5.7 5.2 4.5 QOV total 1.3 0.9 0.9 1.2 2.6 1.9 2.6 2.4 1.7 1.7 2.1 1.1 1.0 1.8 3.0 2.0 2.7 3.4 3.1 2.1 As averyrough estimateofregionalunion density,thevalueofuniondensity was calculated, given the industrial structure of each region for 1972-1 and 1988. Thatis,theexpected union densitywas calculated,assuming thateach sectorisunionizedtothesame extentineveryregion.21The resultsaregiven inTable6. Interms ofitsrankingineachoftheseyears,theMidwestregion hasgone from thirdtofifth. Over thelong term,one would expectfootloose industries to locate away from high labor cost areas, and that the greatest contractions would occur in the least competitive (high input cost) sectors. These two effects would tend to equalize the rates of union density across regions. In other words, one would anticipate thatas the ’younger' regions (the south and west) mature, they will eventually catch up with their older counterparts,intermsoftheirinstitutionalstructure. FRB CHICAGO Working Paper June 1990, WP-1990-6 23 Figure 2 Changes in employment in Midwest, 1973-86 (relative to national trend) millions Table 6 Estimated Union Density Using Industrial Structure ___________________________________ 1972______________ 1988 New England Mid-Atlantic East-North-Central West-North-Central South Atlantic East-South-Central West-South-Central Mountain Pacific U.S. FRB CHICAGO Working Paper June 1990, WP-1990-6 30.4 30.5 32.0 29.9 32.2 33.1 31.2 29.9 29.5 31.1 15.2 15.7 16.3 16.5 16.4 17.7 16.8 16.4 16.0 16.2 24 In summary, union density appears to have fallen in the Midwest, but the evidencesuggeststhatthisreductionhasonlybeen slightlyabovethenational trend. The collective action hypothesis implies that,so faras the effects of laborunionsareconcerned,theMidwestregionhascorrespondinglyincreased itsprospects for growth, but that is true for the United States as a whole. However, as discussed above, labor unions are one of many interestgroups thatreduce growth potentialand economic resilience. Iftheolderregions of the United States contain the highest concentration of labor unions, they probably contain other growth-retarding groups. Unlike labor unions, these othergroups may nothavebeen diminishedby therecentrecessions. Indeed, itisoftenthecasethatonceformed,thesetypesoforganizationsdo noteasily break apart.22 This implies that the Midwest's economy will continue to encounter difficultiesadjustingtoeconomic shocks. On theotherhand, one might reasonably ask why unions would engage in rent-seekingbehavior, if they are aware that eventually their members are likely to become unemployed? Thatis,thesimplefactthateconomic participantsareaware of the damage caused by exclusive, rent-seeking coalitions might change the behavior ofthese coalitions. Such awareness may alsoextendtopoliticians, who may enactlegislationtoreducetheeffectivenessofthesegroups.^ FRB CHICAGO Working Paper June 1990, WP-1990-6 25 Footnotes ^See Sachs, and Bruno and Sachs. ^This paper defines the industrial Midwest as the East-North Central Census region o f the United States or the states of Ohio, Michigan, Illinois, Indiana, and Wisconsin. 'i The new classical school includes among its most prominent members, Robert Lucas, Thomas Sargent, and more recently, Robert Barro. 4 See Olson (1965). ^Hardin makes extensive use o f this paradigm in his analysis o f collective action. 6 See G.D.H. Cole. 7'The term 'political and economic stability' requires elaboration. In many cases successful collusion has occurred after or during destabilizing events, for example, the formation o f the teamsters union during the Great Depression. By 'stable' I mean absence o f revolution or wars that fundamentally alter the political and economic regimes. ^See Gersuny. ^Beside reducing intraunion bargaining costs, the seniority criterion has other advantages. First, using seniority restricts management from arbitrarily dismissing or promoting employees and is, therefore, considered to be a 'fair' procedure. Second, rewarding seniority gives an incentive for workers to provide firms with a reliable source of labor, reducing quits and thereby lowering training costs. Third, the seniority rule can be justified on utilitarian grounds, since an older worker who is made redundant would have less chance o f finding alternative employment than a younger counterpart. Fourth, more senior workers will have acquired more firm specific human capital, so it may benefit both the firm and the worker to retain more experienced workers. ^ F o r example, see Lucas (1975) and Gertler (1982). 1 1See Alchian (1970). 12 AZ,For example, see Fitousse and Phelps, who describe a model where firms are reluctant to adjust their output price for fear o f losing market share. l^T his term is drawn from physics to describe a phenomenon where the strength o f the magnetic field in a ferromagnetic material depends on its 'magnetic history', as well as the magnetizing current presently applied to it. Thus, in the hysteresis theory o f unemployment, the present rate o f unemployment depends on past rates. ^ F o r example, see Blanchard and Summers and Lindbeck and Snower (1986 and 1987). •^ S ee Oswald (1984). ^ I t should be noted that Lindbeck and Snower (1987) implicitly incorporate wage stickiness in their model. The sequence of events in their model is first, the union sets a wage, given the expected labor demand schedule which contains a random component. Second, the random component is realized and the firm sets employment according to the now known' labor demand schedule. Once this occurs, the union must wait until the next period to adjust its wage. ^ M ich igan , Illinois, Ohio, Indiana and Wisconsin, are ranked, 3 , 6 , 7 , 8 and 10, respectively. l^T he results presented in this paper and those mentioned here are in Kendix, and Kendix and Olson. FRB CHICAGO Working Paper June 1990, WP-1990-6 26 1Q Private sector non-agricultural union density was only 12.9 percent in 1988. 2^1 have ignored the government sector because theoretical evidence suggests that public sector unions operate quite differently from those in the private sector. For example, see Oswald, Grout and Ulph. 21 The expected union density in region r at time t, given its industrial structure is where j denotes the industry. EMjrtUDjt, 2 2 See Olson (1982), page 40 ^ A recent example is in Britain, where there is proposed legislation to break down barriers within the legal profession by eliminating the distinction between solicitors and barristers. FRB CHICAGO Working Paper June 1990, WP-1990-6 27 Bibliography Alchian, A. "Information Costs, Pricing and Resource Unemployment." Chapter 1 in Phelps etal,Microeconomic Foundations of Employment and Inflation Theory. W. W. Norton& Company, Inc.,1970. Barro, R. J. and H. I. Grossman, Money, Employment and Inflation. CambridgeUniversityPress,1976. Blanchard, 0. J. and L. H. Summers. "Hysteresis and the European Unemployment Problem." NBER Working Paper Series No. 1950 (June 1986). Bruno, M. and J. D. Sachs, Economics of Worldwide Stagflation. Oxford, 1985. Buchanan, J. M. and G. Tullock, The Calculus of Consent: Logical Foundations of Constitutional Democracy. The UniversityofMichiganPress, 1962;reprint1983. Coe, D. T. "Nominal Wages, The NAIRU and Wage Flexibility." DECD Economic Studies (Autumn 1985):87-126. Coe, D. T. and F. Bagliardi. "Nominal Wage Determination in Ten DECD Countries." OECD Working Paper Series No. 19(1985). Cole,B.D. H.,A Short History of the British Working Class Movement, 17891947. London,B.Allen & Unwin, 1948. Fitoussi, J. P. and E. S. Phelps. "Causes of the 1980s Slump in Europe." Brookings Papers on Economic Activity (2:1986):487-513. Gersuny, C. "Origins of Seniority Provisions in Collective Bargaining." Labor Law Journal (August 1982). Gertler,M. "ImperfectInformationand Wage InertiaintheBusinessCycle." Journal of Political Economy (October 1982). Hardin,R. Collective Action. Published forResources fortheFuture by the JohnHopkinsUniversityPress,1982. Hulten,C. R. and R. M. Schwab. "RegionalProductivityGrowth intheU.S. Manufacturing: 1951-78." The American Economic Review 74 (1:1984): 152162. Kendix, M. "An Investigation Into the Effects of Labor Unions on Unemployment With Decentralized Union-Firm Bargaining Structures: FRB CHICAGO Working Paper June 1990, WP-1990-6 28 Empirical Evidence for Britain, Canada and the United States." Ph.D. dissertation,UniversityofMaryland, 1988. Kendix, M. and M. Olson. "Changing Unemployment Rates in Europe and the U.S.: Institutional Structure and Regional Variation" paper presented at theI nternationalEconomicAssociation,meetingsinVenice,Italy(September 1988). Lindbeck, A. and D. J.Snower. "Union Activity,Unemployment Persistence and Wage-Employment Ratchets." EuropeanEconomicReview21 (1987): 157-167. Lucas Jr.,R. E. "An Equilibrium Model oftheBusiness Cycle." Journalof PoliticalEconomy83 (December 1975). Muellbauer, J. and R. Portes. "Macroeconomic Models with Quantity Rationing." TheEconomicJournal(December 1987). Olson, M. TheLogicofC ollectiveAction:PublicGoodsandtheTheoryof Groups. Cambridge, Massachusetts and London, England: Harvard UniversityPress, 1965;reprint,1982. Olson, M. TheRiseandDeclineofNations:EconomicGrowth,S tagflation andSocialRigidities.New Haven andLondon: YaleUniversityPress,1982. Olson, M. "Maintaining a Healthy Business Climate: A Broader Perspective on the Rates ofEconomic Growth and Unemployment in the Southern and Southwestern States."I nEnergyandtheSouthwestEconomy:Proceedingsof the1985ConferenceonEnergyandtheSouthwestEconomyinDallas,Texas, by theFederalReserve Bank ofDallas. Dallas Texas: Federal Reserve Bank ofDallas,1906. Oswald, A. J. "EfficientContracts are on theLabor Demand Curve: Theory andFacts."I ndustrialRelationsSector.PrincetonUniversity,WorkingPaper SeriesNo.178(July 1984). Oswald, A. J. ’’The Economic Theory of Trade Unions: An Introductory Survey." ScandinavianJournalofEconomics87 (2: 1985): 160-193. Oswald, A. J.,P. A. Grout and D. T. Ulph. "Uncertainty, Unions and the Theory of Public Sector Labor Markets." I ndustrialRelationsSection, PrincetonUniversity,WorkingPaperSeriesNo. 176(July1984). Sachs, J. D. "High Unemployment in Europe: Diagnosis and Policy Implications."NBERWorkingPaperS eriesNo. 1830(1986). FRB CHICAGO Working Paper June 1990, WP-1990-6 29 Summers, L. H. "Why is the Unemployment Rate So Very High Near Full Employment?” Brookings Papers on Economic Activity (2:1986): 339-383. FRB CHICAGO Working Paper June 1990, WP-1990-6 30 Federal Reserve Bank of Chicago RESEARCH STAFF MEMORANDA, WORKING PAPERS AND STAFF STUDIES The following lists papers developed in recent years by the Bank’s research staff. Copies of those materials that are currently available can be obtained by contacting the Public Information Center (312) 322-5111. Working Paper Series—A series of research studies on regional economic issues relating to the Sev enth Federal Reserve District, and on financial and economic topics. Regional Economic Issues ♦WP-82-1 Donna Craig Vandenbrink “The Effects of Usury Ceilings: the Economic Evidence,” 1982 David R. Allardice “Small Issue Industrial Revenue Bond Financing in the Seventh Federal Reserve District,” 1982 WP-83-1 William A. Testa “Natural Gas Policy and the Midwest Region,” 1983 WP-86-1 Diane F. Siegel William A. Testa “Taxation of Public Utilities Sales: State Practices and the Illinois Experience” WP-87-1 Alenka S. Giese William A. Testa “Measuring Regional High Tech Activity with Occupational Data” WP-87-2 Robert H. Schnorbus Philip R. Israilevich “Alternative Approaches to Analysis of Total Factor Productivity at the Plant Level” WP-87-3 Alenka S. Giese William A. Testa “Industrial R&D An Analysis of the Chicago Area” WP-89-1 William A. Testa “Metro Area Growth from 1976 to 1985: Theory and Evidence” WP-89-2 William A. Testa Natalie A. Davila “Unemployment Insurance: A State Economic Development Perspective” WP-89-3 Alenka S. Giese “A Window of Opportunity Opens for Regional Economic Analysis: BEA Release Gross State Product Data” WP-89-4 Philip R. Israilevich William A. Testa “Determining Manufacturing Output for States and Regions” WP-89-5 Alenka S.Geise “The Opening of Midwest Manufacturing to Foreign Companies: The Influx of Foreign Direct Investment” WP-89-6 Alenka S. Giese Robert H. Schnorbus “A New Approach to Regional Capital Stock Estimation: Measurement and Performance” **WP-82-2 ♦Limited quantity available. **Out of print. Working Paper Series (cont'd) WP-89-7 William A. Testa “Why has Illinois Manufacturing Fallen Behind the Region?” WP-89-8 Alenka S. Giese William A. Testa “Regional Specialization and Technology in Manufacturing” WP-89-9 Christopher Erceg Philip R. Israilevich Robert H. Schnorbus “Theory and Evidence of Two Competitive Price Mechanisms for Steel” WP-89-10 David R. Allardice William A. Testa “Regional Energy Costs and Business Siting Decisions: An Illinois Perspective” WP-89-21 William A. Testa “Manufacturing’s Changeover to Services in the Great Lakes Economy” WP-90-1 P.R. Israilevich “Construction of Input-Output Coefficients with Flexible Functional Forms” WP-90-4 Douglas D. Evanoff Philip R. Israilevich “Regional Regulatory Effects on Bank Efficiency” WP-90-5 Geoffrey J.D. Hewings “Regional Growth and Development Theory: Summary and Evaluation” WP-90-6 Michael Kendix “Institutional Rigidities as Barriers to Regional Growth: A Midwest Perspective” Issues in Financial Regulation WP-89-11 Douglas D. Evanoff Philip R. Israilevich Randall C. Merris “Technical Change, Regulation, and Economies of Scale for Large Commercial Banks: An Application of a Modified Version of Shepard’s Lemma” WP-89-12 Douglas D. Evanoff “Reserve Account Management Behavior: Impact of the Reserve Accounting Scheme and Carry Forward Provision” WP-89-14 George G. Kaufman “Are Some Banks too Large to Fail? Myth and Reality” WP-89-16 Ramon P. De Gennaro James T. Moser “Variability and Stationarity of Term Premia” WP-89-17 Thomas Mondschean “A Model of Borrowing and Lending with Fixed and Variable Interest Rates” WP-89-18 Charles W. Calomiris “Do "Vulnerable" Economies Need Deposit Insurance?: Lessons from the U.S. Agricultural Boom and Bust of the 1920s” ♦Limited quantity available. ♦♦Out of print. Working Paper Series (cont'd) WP-89-23 George G. Kaufman “The Savings and Loan Rescue of 1989: Causes and Perspective” WP-89-24 Elijah Brewer III “The Impact of Deposit Insurance on S&L Shareholders’ Risk/Return Trade-offs” Macro Economic Issues WP-89-13 David A. Aschauer “Back of the G-7 Pack: Public Investment and Productivity Growth in the Group of Seven” WP-89-15 Kenneth N. Kuttner “Monetary and Non-Monetary Sources of Inflation: An Error Correction Analysis” WP-89-19 Ellen R. Rissman “Trade Policy and Union Wage Dynamics” WP-89-20 Bruce C. Petersen William A. Strauss “Investment Cyclicality in Manufacturing Industries” WP-89-22 Prakash Loungani Richard Rogerson Yang-Hoon Sonn “Labor Mobility, Unemployment and Sectoral Shifts: Evidence from Micro Data” WP-90-2 Lawrence J. Christiano Martin Eichenbaum “Unit Roots in Real GNP: Do We Know, and Do We Care?” WP-90-3 Steven Strongin Vefa Tarhan “Money Supply Announcements and the Market’s Perception of Federal Reserve Policy” WP-90-7 Prakash Loungani Mark Rush “Sectoral Shifts in Interwar Britain” WP-90-8 Kenneth N. Kuttner “Money, Output, and Inflation: Testing The P-Star Restrictions” WP-90-9 Lawrence J. Christiano Martin Eichenbaum “Current Real Business Cycle Theories and Aggregate Labor Market Fluctuations” WP-90-10 S. Rao Aiyagari Lawrence J. Christiano Martin Eichenbaum “The Output, Employment, And Interest Rate Effects of Government Consumption” *Limited quantity available. **Out of print. Staff Memoranda—A series of research papers in draft form prepared by members of the Research Department and distributed to the academic community for review and comment. (Series discon tinued in December, 1988. Later works appear in working paper series). **SM-81-2 George G. Kaufman “Impact of Deregulation on the Mortgage Market,” 1981 **SM-81-3 Alan K. Reichert “An Examination of the Conceptual Issues Involved in Developing Credit Scoring Models in the Consumer Lending Field,” 1981 Robert D. Laurent “A Critique of the Federal Reserve’s New Operating Procedure,” 1981 George G. Kaufman “Banking as a Line of Commerce: The Changing Competitive Environment,” 1981 SM-82-1 Harvey Rosenblum “Deposit Strategies of Minimizing the Interest Rate Risk Exposure of S&Ls,” 1982 ♦SM-82-2 George Kaufman Larry Mote Harvey Rosenblum “Implications of Deregulation for Product Lines and Geographical Markets of Financial Instititions,” 1982 •SM-82-3 George G. Kaufman “The Fed’s Post-October 1979 Technical Operating Procedures: Reduced Ability to Control Money,” 1982 SM-83-1 John J. Di Clemente “The Meeting of Passion and Intellect: A History of the term ‘Bank’ in the Bank Holding Company Act,” 1983 SM-83-2 Robert D. Laurent “Comparing Alternative Replacements for Lagged Reserves: Why Settle for a Poor Third Best?” 1983 **SM-83-3 G. O. Bierwag George G. Kaufman “A Proposal for Federal Deposit Insurance with Risk Sensitive Premiums,” 1983 ♦SM-83-4 Henry N. Goldstein Stephen E. Haynes “A Critical Appraisal of McKinnon’s World Money Supply Hypothesis,” 1983 SM-83-5 George Kaufman Larry Mote Harvey Rosenblum “The Future of Commercial Banks in the Financial Services Industry,” 1983 SM-83-6 Vefa Tarhan “Bank Reserve Adjustment Process and the Use of Reserve Carryover Provision and the Implications of the Proposed Accounting Regime,” 1983 SM-83-7 John J. Di Clemente “The Inclusion of Thrifts in Bank Merger Analysis,” 1983 SM-84-1 Harvey Rosenblum Christine Pavel “Financial Services in Transition: The Effects of Nonbank Competitors,” 1984 SM-81-4 **SM-81-5 ♦Limited quantity available. **Out of print. Staff Memoranda (cont'd) SM-84-2 George G. Kaufman “The Securities Activities of Commercial Banks,” 1984 SM-84-3 George G. Kaufman Larry Mote Harvey Rosenblum “Consequences of Deregulation for Commercial Banking” SM-84-4 George G. Kaufman “The Role of Traditional Mortgage Lenders in Future Mortgage Lending: Problems and Prospects” SM-84-5 Robert D. Laurent “The Problems of Monetary Control Under Quasi-Contemporaneous Reserves” SM-85-1 Harvey Rosenblum M. Kathleen O’Brien John J. Di Clemente “On Banks, Nonbanks, and Overlapping Markets: A Reassessment of Commercial Banking as a Line of Commerce” SM-85-2 Thomas G. Fischer William H. Gram George G. Kaufman Larry R. Mote “The Securities Activities of Commercial Banks: A Legal and Economic Analysis” SM-85-3 George G. Kaufman “Implications of Large Bank Problems and Insolvencies for the Banking System and Economic Policy” SM-85-4 Elijah Brewer, III “The Impact of Deregulation on The True Cost of Savings Deposits: Evidence From Illinois and Wisconsin Savings & Loan Association” SM-85-5 Christine Pavel Harvey Rosenblum “Financial Darwinism: Nonbanks— and Banks—Are Surviving” SM-85-6 G. D. Koppenhaver “Variable-Rate Loan Commitments, Deposit Withdrawal Risk, and Anticipatory Hedging” SM-85-7 G. D. Koppenhaver “A Note on Managing Deposit Flows With Cash and Futures Market Decisions” SM-85-8 G. D. Koppenhaver “Regulating Financial Intermediary Use of Futures and Option Contracts: Policies and Issues” SM-85-9 Douglas D. Evanoff “The Impact of Branch Banking on Service Accessibility” SM-86-1 George J. Benston George G. Kaufman “Risks and Failures in Banking: Overview, History, and Evaluation” SM-86-2 David Alan Aschauer “The Equilibrium Approach to Fiscal Policy” ’•'Limited quantity available. **Out of print. Staff Memoranda (cont'd) SM-86-3 George G. Kaufman “Banking Risk in Historical Perspective” SM-86-4 Elijah Brewer III Cheng Few Lee “The Impact of Market, Industry, and Interest Rate Risks on Bank Stock Returns” SM-87-1 Ellen R. Rissman “Wage Growth and Sectoral Shifts: New Evidence on the Stability of the Phillips Curve” SM-87-2 Randall C. Merris “Testing Stock-Adjustment Specifications and Other Restrictions on Money Demand Equations” SM-87-3 George G. Kaufman “The Truth About Bank Runs” SM-87-4 Gary D. Koppenhaver Roger Stover “On The Relationship Between Standby Letters of Credit and Bank Capital” SM-87-5 Gary D. Koppenhaver Cheng F. Lee “Alternative Instruments for Hedging Inflation Risk in the Banking Industry” SM-87-6 Gary D. Koppenhaver “The Effects of Regulation on Bank Participation in the Market” SM-87-7 Vefa Tarhan “Bank Stock Valuation: Does Maturity Gap Matter?” SM-87-8 David Alan Aschauer “Finite Horizons, Intertemporal Substitution and Fiscal Policy” SM-87-9 Douglas D. Evanoff Diana L. Fortier “Reevaluation of the Structure-ConductPerformance Paradigm in Banking” SM-87-10 David Alan Aschauer “Net Private Investment and Public Expenditure in the United States 1953-1984” SM-88-1 George G. Kaufman “Risk and Solvency Regulation of Depository Institutions: Past Policies and Current Options” SM-88-2 David Aschauer “Public Spending and the Return to Capital” SM-88-3 David Aschauer “Is Government Spending Stimulative?” SM-88-4 George G. Kaufman Larry R. Mote “Securities Activities of Commercial Banks: The Current Economic and Legal Environment SM-88-5 Elijah Brewer, III “A Note on the Relationship Between Bank Holding Company Risks and Nonbank Activity” SM-88-6 G. O. Bierwag George G. Kaufman Cynthia M. Latta “Duration Models: A Taxonomy” G. O. Bierwag George G. Kaufman “Durations of Nondefault-Free Securities” ♦Limited quantity available. ♦♦Out of print. Staff Memoranda (cont'd) SM-88-7 David Aschauer “Is Public Expenditure Productive?” SM-88-8 Elijah Brewer, III Thomas H. Mondschean “Commercial Bank Capacity to Pay Interest on Demand Deposits: Evidence from Large Weekly Reporting Banks” SM-88-9 Abhijit V. Banerjee Kenneth N. Kuttner “Imperfect Information and the Permanent Income Hypothesis” SM-88-10 David Aschauer “Does Public Capital Crowd out Private Capital?” SM-88-11 Ellen Rissman “Imports, Trade Policy, and Union Wage Dynamics” Staff Studies A series of research studies dealing with various economic policy issues on a national level. SS-83-1 **SS-83-2 Harvey Rosenblum Diane Siegel “Competition in Financial Services: the Impact of Nonbank Entry,” 1983 Gillian Garcia “Financial Deregulation: Historical Perspective and Impact of the Garn-St Germain Depository Institutions Act of 1982,” 1983 ♦Limited quantity available. **Out of print.
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