Macroeconomic Effects of Labor and Industrial Policies

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

This research continues work by the investigator on the macroeconomic effects of labor and industrial policies. The prior research developed a multi-sector dynamic general equilibrium insider/outsider model and used that model to quantitatively evaluate the macroeconomic impact of President Roosevelt's cartelization and labor market policies in the 1930s. The main finding of my previous research is that these New Deal policies were a key factor in the continuation of the Great Depression until World War II. The new research broadens and extends this work in two significant ways and so in doing resolves some key puzzles identified in the previous work. First, it develops a dynamic general equilibrium insider/outsider model with "hold-up": the ability of workers to grab rents from capital. This is a substantial theoretical innovation over the model in the previous work, which abstracted from hold-up. Theoretically, the model merges the earlier dynamic GE insider/outsider model with a hold-up friction in that workers can grab rents from firm investments made prior to the time that firms and workers bargain. The project shows how the equilibrium can be characterized and how it can be computed even with the additional complexity arising from industry-specific capital. This model has substantive quantitative implications for historical episodes in which government policies permitted labor to hold up capital. This model is used to study the macroeconomic effects of the National Labor Relations Act (NLRA), which gave labor a significant ability to hold up firms. The specification of the model captures some key aspects of New Deal policies. The model with hold-up helps resolve two key puzzles highlighted in my earlier work: (1) the further deterioration of the economy after the NLRA was passed, and (2) the extraordinary low level of investment. The hold-up model predicts a further drop in output and employment and a further increase in the real wage after the NLRA was adopted, which is consistent with the data. The model also predicts a much lower level of investment than predicted by the earlier model without hold-up, and thus brings the theory closer in line with data. This finding suggests that "rent-grabbing" was a key factor that kept investment low during the New Deal. The proposal also outlines the application of this model to Europe. Second, past work is broadened by studying unemployment insurance policies that affect labor supply. A dynamic general equilibrium model is developed to study the macroeconomic implications of some historical depressions in which countries have adopted very generous unemployment benefits systems. This work indicated that Britain's unemployment insurance system -in conjunction with large, negative sector-specific shocks - was a key contributing factor to the depression. The new research develops a fully articulated model to quantitatively evaluate the macroeconomic impact of unemployment benefits during interwar Britain and during other historical episodes. This research differs considerably from the large existing literature that has analyzed the interwar British depression. It makes considerable use of dynamic general equilibrium theory, and it does not exclusively focus on UI. In fact, the research discusses how UI cannot be the whole story, because post-World War II employment was considerably higher than interwar employment, despite comparable levels of benefits. By focusing on the fact that Britain suffered large, negative sectoral shocks after World War I, but not after World War II, the research suggests a unified accounting of interwar and post-World War II. It develops a multi-sector model that includes a search friction on employment and takes into account the drop in human capital associated with sectoral shifts and spells of unemployment. Such a model is capable of assessing the impact of the large sectoral shocks on Britain's interwar unemployment given its generous VI system. The model is used to study Europe in 1980s. A number of researchers have suggested that the problems Europe experienced during this period arose from a combination of generous unemployment benefits, high degrees of labor bargaining power and large sectoral shocks. Finally, the project constructs a comprehensive cross-country database on interwar economies to help foster additional research on the interwar period. This will be the only fully documented, downloadable database on this period available.