Some Notes on the Economics of Unions: Part I

Matt Steinglass at the Economist has replied to my recent piece on how liberals often ignore labor markets by outlining how we can have more unionization without less employment.  His argument goes like this:  unions capture profits and increase the labor share of national income. This increases aggregate demand, which fuels growth and leads to higher employment. I’m going to address this argument in two posts, since the reply will be lengthy.

The first question I want to address is “if unions increase wages by capturing profits, would it increase economic growth?” I think this argument suffers from what I’d like to call the fallacy of permanent Keynesianism. It’s true that there is slack in the economy right now, and that increasing consumption and therefore aggregate demand will increase economic growth. But the level of unionization in the economy is a long-term structural and institutional issue, not a short-term countercyclical one.  Attempting to increase consumption like this will come at the expense of savings, which in the long-run means lower investment, a lower capital stock, and therefore lower economic growth. In short, more consupmtion does not necessarily mean more economic growth. Consider, as a simple example, the Golden Rule of savings in a Solow growth model.

In fact, in a symposium commemorating the 25th anniversary review of his celebrated book “What do unions do?”, labor economist and union defender Richard Freeman makes the complete opposite argument as Steinglass.  He argues that the negative direct impact of of unions on economic growth (which, as discussed below, he acknowledges) may be offset by an increase in workers’ savings that result from labor contracts with larger pensions.

But even if it were true that more consumption always meant more economic growth, I do not agree with Matt’s contention that unionization would increase the labor share of national income. The following graph shows the ratio of labor compensation to corporate profit from the BEA’s NIPA tables. While Matt is right that this ratio is at a historical low, notice that the pattern bears no relationship to the level of unionization in the economy, shown in the graph below it.

Labor’s share of national income actually fares much better when you use the definition used by Robert Gordon and Ian Dew-Becker in their paper on inequality.

Here the denominator is GNP minus consumption of fixed capital, minus indirect business taxes. While the number has fallen recently, it is well above historical lows, and well above what it was during the heydey of unionism. Again, the important thing is there is nothing to indicate that the decline in unionization has affected labor’s share. Gordon and Dew-Becker conclude in their paper:

“Thus,to a first approximation, we conclude that the increase in American inequality after the mid-1960s has little to do with labor’s share in domestic income.  What has happened is a sharp increase in skewness within labor compensation.”

However, even if unionization doesn’t allow labor to capture profits in the aggregate, the empirical evidence (some of which is summarized usefully here by Barry Hirsch, more can be found in the symposium discussed above) does suggest that it happens within unionized firms. But is this a good thing as Matt believes? The problem is that measured profits, when they are rents that unions can potentially capture at all, can be either pure rents or they can be quasi-rents. In the long-run, competition eats away at pure rents, and quasi-rents that represent normal returns to long-lived physical and non-tangible capital are necessary and important. Allowing unions to ex-post grab quasi-rents to long-lived capital incentivizes firms away from making those investments in the first place. In fact the empirical evidence on this topic shows that unionized firms have less profit, less investment, and less R&D spending.

While Matt seems to disagree, the notion that unionized firms suffer from lower employment is actually not a very controvertial claim among labor economists.  For instance, in his aforementioned book, Richard Freeman agrees that union firms not only have lower rates of R&D, investment, as discussed above, but that they have lower employment growth. He argues that this may not negatively impact economic growth if the decreases in union firms are offset by increased investment, R&D, and employment growth by non-union firms. But this is exactly the problem with arguing for a more unionized economy: the only way it isn’t damaging is if there are nonunion firms to take up the slack and grow. In the long-run, this suggests a steady decline of unionization is inevitable.

There is another major disconnect between the way liberal writers like Matt and liberal labor economists like Freeman write about unions. Typically, the former praise the so-called “monopoloy face” of unions, whereas the latter usually recognize that unions ability to raise wages above market level is a downside of unions. Labor economists who support unions tend to do so for what economists call the “voice face” of unionism. Indeed, I think this positive aspect of unions, whereby they communicate with owners and managers the desires of the workers, is underestimated by many conservative writers. The “voice face” of unions can lead unionization to have a positive impact on firm productivity. Granted, there are a lot of issues here, like the possibility of alternative ways of providing workers voice that don’t risk a “monopoly face”, and the fact that the empirical impact of unions on productivity is ambiguous whereas the wage impact is not. But suffice it to say that the aspect of unions liberal writers praise is often recognized by prominant liberal labor economists as a problem.

Next I’ll discuss why unionization has fallen in the first place, why high unions could co-exist with low unemployment in the 50s and 60s, and why both of these things tell us that high unionization is undesirable today.

Skepticism and Cynicism

One of the things I have noticed on the blogosphere, Facebook and other outlets where I have access to popular opinion is that skepticism goes out the window when it collides with cynicism.

In an only mild exaggeration, if I were to propose that the moon were made out of cheese, I would be met with a deep skepticism by almost everyone. However, if I were to propose to a unified subgroup, that their sociopolitical adversaries had conspired  to make them believe the moon was not made out of cheese the skepticism level would drop dramatically.

Still most people would combat it, but far less forcefully and more on the grounds that “every knows that the moon is not made of cheese” rather than on genuine skepticism.

However, no matter how likely you think it is that some one is tricking you into believe the moon is not made cheese, that must be less likely than moon being actually made out of cheese. For someone to hide the truth from you, it must first be the truth.

 

Let me give a more concrete but unfortunately more charged example. There is a debate over whether or not the Obama Stimulus worked. As I have said before, I favored a different type of stimulus, both at the time and now. This gives me enough cachet to enter into non-heated conversations with strong Obama detractors.

They ask me frequently whether or not I “really believe” the stimulus worked. I say, “I presume so.” Then they counter with a line of reasoning more or less like the following:

The economy was bad even with the stimulus. It was worse in fact than the Obama administration said it would be without the stimulus. The Obama administration would like us to believe that it would have been even worse without their stimulus. However, this is just a convenient ruse. One cannot prove a counter-factual. Thus we cannot know whether the economy would have been worse without the stimulus. Thus we should not believe the Obama’s administration’s claim that stimulus worked.

This is all well and good except that its an argument that the Obama administration has no credibility on stimulus. That fact alone can’t lower your estimate of stimulus’s effectiveness from what it was before the crisis.

Why?

Well presumably the Obama administration, at absolute worst, will say whatever it needs to say to put the stimulus in the best light. If the stimulus worked, they will say it worked. If it did not work then they will still say it worked.

This implies that statements from the Obama administration are orthogonal to the truth. That is, utterly uninfluenced by it.

However, if a statement is orthogonal to the truth then it cannot rationally affect your estimate of the truth. That is, it simply doesn’t matter what the Obama administration says. Your best guess at the truth is whatever you thought the truth was before. You might as well simply ignore everything the Obama administration says.

Yet, this is not what the argument above is asking. It is asking that I lower my estimate that stimulus is effective based on the Obama administration’s lack of credibility. This is only rational if I think the Obama administration is anti-truth. That is, that they seek to lie even when it is not in their best interest to do so.

Or, said another way I have to believe if the stimulus had worked the Administration would lie to me and tell me that it didn’t. I have to believe they would do this because they enjoy lying or are otherwise motivated to spread disinformation for its own sake.

Said, in additional way, I have to believe not that the Obama administration has no credibility, but that they have negative credibility. If I take what they say and simply assume the opposite, I will be right more than not.

Its an easy proof but beyond this post that negative credibility is credibility. And, that someone who always lied no matter what, is just as trustworthy as someone who always tells the truth. You simply have to logically invert the questions.

So, back to the point, this implies that, at worst, the Obama administration has zero credibility. Negative credibility would be better than zero credibility.

However, zero credibility by definition means that you should believe whatever you believed before. It also by the way, means that the fact that the economy was worse than the Obama administration predicted means nothing. After all, they have zero credibility. Under that assumption, everything they say is meaningless.

The moral of that example is that there is no consistent amount of cynicism about the Obama Administration that should lead you to downgrade your estimate that stimulus worked.

Now, if you independent of the Administration, thought that unemployment would top out at 9% in the absence of stimulus, and you independently hold to that prediction then the fact that with stimulus unemployment rose above 9% is evidence that the stimulus failed. However, it’s a rare person that I meet, who is making this claim.

The moral of the whole post is that assuming your adversaries have low fidelity to the truth is not the same as assuming that they have high fidelity to lies. Generally speaking the worst I should think of someone is that, something is no more or less likely because they told me it was so. I should not lower my skepticism of their proposition being false, simply because they told me it was true.

Mr. Yglesias and the Classics

One of Matt Yglesias’s commenters offers this concern

I fear we’ll get a society where perhaps 10% of the people will own all the land and capital, and they will hire 60% of the people to work for low but comfortable wages, while 30% will be totally dependent on a welfare and the odd temporary job every now and then.

If this scenario is a real possibility, then the only solution I can imagine is highly progressive taxation and wealth distribution, so that the great masses can afford to employ each other (with restaurant meals and dance lessons).

After offering me a shout-out, Yglesias says

At any rate, I’m not blogging about land use at the moment because I’m hoping to build enthusiasm for a potential book, so let’s focus on the “capital” side of this arrangement. What’s missing from the doom analysis (and this is fresh in my mind since coincidentally I’ve been reading Ricardo) is the “human capital.” Employee compensation accounts for the majority of GDP because the majority of the actual capital available to the economy is inside people’s heads.

I’ll offer my interpretation of the phenomenon. It is decidedly neo-classical.

Redistribution is desirable because it raises the living standard of the person we are redistributing to. However, welfare-reinforcing-the-culture-of-poverty arguments aside, it shouldn’t change the basic structure of pre-tax national income.

In a completely free market economy the share of national income that goes to the various factors of production are determined by their role in production. To the extent human capital has a more important role, human capital will command more of national income. The same is true for physical capital and raw labor power.

However, the rents, to the factors are determined by their reproducibility. That is, how easy is it to make more.

The majority of the rise is living standards for workers occurred because they – the workers – were relatively irreproducible. It takes, according to modern law, 16 years to produce a new worker. Most producers, that is to say parents, are not induced, through higher wages, to produce more workers.

So the following scenario ensues. The economy grows larger and larger. Labor, even raw labor, has some productive role in the economy and so it has a share in this growth. However, the number of laborers is not growing as fast as the economy. Thus, labor’s share of the economic pie grows faster than the total number of laborers and so the share of the economic pie per laborer grows.

What we seem to be facing at the moment is culmination of several forces. I think most economists from Tyler Cowen to David Card agree that the production of human capital has become more constrained, while its role in production is growing.

The result is that the economy is growing, human capital’s share of the economy is growing, but the quantity of human capital is not growing as fast as it could be. Therefore, the slice of the economic pie going to each “bit” of human capital is growing very rapidly. We see this in a rising return to education, technology, general smarts etc.

At the same time are seeing massive growth in the pool of laborers. More laborers from rural China move to the city everyday and economic liberalism marches across South and South East Asia. This radically increases the pool of labor.

Labor is still relatively hard to come by, by historical standards. However, it is not as hard to come by as it once was. Moreover, increases in the return to labor are indeed increasing the supply of labor as higher wages increase the speed at which farm workers leave for the city.

This means that the global economy is growing, the share going to labor is growing slightly slower – because it is being crowded out by human capital – but the size of the labor pool is growing faster and faster. Thus, labor’s slice of the economic pie is barely keeping pace with the size of the labor pool, itself. The result is a stagnant slice per laborer.

Indeed, I think the slice is probably declining in the Western World, so that a person with no knowledge or skills whatsoever, earns less today that he would have 20 years ago.

I would guess that is similar to the  phenomenon the classical economists witnessed. Labor was migrating steadily into the city, drawn by higher wages. To some extent – though less than they envisioned –  increased wages also allowed for larger families. This meant that while the economy was growing, and with it labor’s share, the share per worker was not growing or growing very slowly.

At the same time, capital markets were highly underdeveloped. It was not easy to produce new capital. Capital’s share of the economy was increasing steadily right along with labor. However, the number of capitalists was not increasing. Thus the slice of the economic pie per capitalist was exploding.

This trend reversed itself, mainly as the result of several forces: family size stopped growing, the rural labor pool was exhausted and capital markets opened up, allowing a rapid increase in the number of capitalists and the amount of capital available.

The greatest potential source of relief for low skilled Americans will be exhaustion of the global rural labor force. This will mean primarily a fully industrialized Asia. This will exert itself in one of two ways.

If Asian countries retain their very high savings rate then it will occur as enormous foreign direct investment (FDI) in the United States. Chinese and Indian corporations will set up shop in the United States and bid up the demand for raw US labor. One might be tempted to think that this FDI will only support “skilled jobs” but marginalist thinking suggests not.

As the price of skilled workers rises some tasks will be substituted by unskilled workers. Making predictions about what this will look like is hard, especially since it involves the future. However, an one easy vision is to imagine a world where grocery stores turn into a massive “fresh counters” where all the prep work necessary for your meal is done to order from fresh ingredients. You go home with little premeasured containers that you can combine into the recipe you want as easily as Food Network chefs do.

This is a pampered life for high skilled workers, but its also a world in which unskilled workers can regularly find work capable of supporting their families and an ever increasing standard of living.

Another alternative is for savings in Asian to decline, which would shift the balance of trade and cause at least a temporary surge in manufacturing done in the US. The transition period would be different in this scenario, but the end game likely the same. There would be a bidding up of the returns to capital in the US and rather than FDI, domestic investment would bring about the future.

A strange model of the economy, ctd

Ryan Avent at the Economist explains much more clearly than I the wrongness of the claim that low population growth will make us better off:

The point concerning government spending is simply bizarre. Projected growth in federal spending is largely due to rising spending on entitlements, especially Medicare and Medicaid. Slower population growth isn’t going to limit this spending growth; it will just increase the dependency ratio and the expected per capita burden of taxation….

…Indeed, all of the above is precisely what has been observed in Japan, where population growth slowed, halted, and eventually reversed. Per capita incomes have risen only very slowly, government debt is enormous, households are heavy savers, and deflation is endemic.

Also in the comments Andy Harless tries to provide an explanation for what Johnson may be thinking:

(1) fewer immigrants mean less competition for jobs in the short run (assuming immigrants don’t create enough domestic demand to support their employment), and (2) fewer children mean less drain on governments. Of course fewer children do also mean less demand and therefore fewer jobs, but this is obviously endogenous: children are just a manifestation of the multiplier effect, an expense that people choose based on their income. OTOH immigration is also endogenous, so all the first argument is really saying is that it’s a good thing people aren’t dumb enough to keep coming to the US when there are no jobs.

I think this is quite possibly what Johnson is thinking, and I like Andy I think there are some big problems with it. I won’t rehash the arguments here, but there are a lot of other reasons why more immigration would make us better off.

Commenter Adam and Matt Yglesias (via twitter) also point out that an economy based mainly on some scarce natural resource or agriculture could have diminishing returns to labor even in the long-run as capital adjusts, which would explain higher real wages as population grows. However as Matt, Adam, and I agree, this a very bad model of the U.S. economy.

Karl addresses the monetary impacts in the comments:

More worker would imply an increasing demand for money. If you are thinking of the money stock as fixed this will tend to be deflationary and worsen our condition.

However, we have a rate target so increasing money demand should be met by increasing lending. More population should supply more credit unconstrained borrowers who can profitably take out loans at the prevailing interest rate.

Overall I am less puzzled by what Johnson could be thinking, but don’t see a plausible case for why he could be right.

A strange model of the economy

Can someone explain to me a model of an economy where this makes sense?

For the economy, a slower increase in the population raises concerns about American competitiveness. But it could actually be a good thing. A number of economists, including the Federal Reserve Chairman Ben Bernanke are worried about the lack of inflation and income growth in the United States. Fewer workers could drive up salaries. What’s more, fewer new Americans might help slow government spending. That may curtail the rising US federal debt, which many think will soon cause interest rates to jump and hold down US GDP growth. “At a time of fewer government resources, fewer new people might not be such a bad thing,” says New Hampshire’s Johnson.

This seems very wrong to me. For one thing we have an aging population who we are going to need to support, and the less working age population we have to support them the more of a burden they become. Like a pyramid scheme you can’t permanently improve this situation with faster and faster population growth, but you certainly can make the situation worse by decreasing the number of working people per retired person. In addition, lots of government spending, like defense spending, is non-rivalrous public goods so that a higher the population means a lower the per-capita cost. I’m very curious to hear how Kenneth Johnson, the “population expert” from which this claim comes, sees per-capita government spending decreasing. Or perhaps he is talking only about total spending, but why should that be a concern?

Likewise I find his claim that lower population growth will drive up salaries to be confusing. After all one man’s salary is another man’s price, which decreases his real wage. Perhaps he thinks there are basically two types of people: skilled and unskilled. And that what’s really happening is population growth is decreasing in the unskilled which will make them more scarce relative to the skilled, and thus able to command a higher wage. I don’t find this very believable, either empirically or as a model for our economy.

Can someone explain to me a model where decreasing population growth raises real wages and decreases per capita government spending? I do not mean to be dismissive of Professor Johnson or his claims, but I am at a loss here.