Real Origins of the Great Depression

Real Origins of the Great Depression
Monopoly Power, Unions and the Interwar Business Cycle
Monique Ebell
HU Berlin & LSE
Albrecht Ritschl
LSE & CEPR
May 2010
Ebell/Ritschl (LSE & HU Berlin)
Real Origins of the Great Depression
May 2010
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Previous Work on the Interwar Economy
Business Cycle Accounting approach of Chari, Kehoe & McGrattan
(2002)
Key role for e¢ ciency and labor wedges
Focus on Great Depression and aftermath 1929-39
Cole & Ohanian (2002) for UK, Hornstein (2002) for Germany,
Beaudry & Portiers (2002) for France
Business Cycle Accounting framework
Perfect compeition in goods markets
Walrasian labor markets
Cole and Ohanian (2004)
Explicit modelling of frictions
Speci…c to New Deal institutions
Focus on slow recovery from Great Depression 1933 onwards
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Real Origins of the Great Depression
May 2010
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Our Contributions
1
Scope
Severe recession 1919-21, accompanying stock market crash
Recovery to trend 1922-29, stock market boom
Onset of the Great Depression 1929-31, stock market crash
2
Explicit modelling of frictions
Interactions between monopoly power and wage bargaining
Unemployment
Explanatory power for asset markets
3
History
Identify 3 major shifts in legal environment for organized labor:
1914/19, late 1921, 1929
Threat point of organized labor strengthened in a series of
developments during 1929, culminating in October 1929
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Real Origins of the Great Depression
May 2010
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Real Dow Jones Industrial Average, 1913-1939
Relative to 1.8% trend
300.0
250.0
200.0
150.0
100.0
50.0
0.0
1913 1914 1916 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
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Real Origins of the Great Depression
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Real Private Non-Farm Per Capita GDP
Relative to 1.8% trend
110
100
90
80
70
60
50
40
1913 1914 1915 1916 1917 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
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Real Origins of the Great Depression
May 2010
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The Interwar Business Cycle
Non-Farm Unemployment 1913-1939
35
30
25
20
15
10
5
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Real Origins of the Great Depression
1939
1938
1937
1936
1935
1934
1933
1932
1931
1930
1929
1928
1927
1926
1925
1924
1923
1922
1921
1920
1919
1918
1917
1916
1915
1914
1913
0
May 2010
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Real Wages in Manufacturing, 1929-1939
Relative to 1.8% trend, de‡ated by PPI
1.200
1.150
1.100
1.050
1.000
0.950
0.900
1928
1929
1930
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1931
1932
1933
1934
1935
Real Origins of the Great Depression
1936
1937
1938
May 2010
1939
7 / 43
Interwar Labor Law Regimes
1
Clayton Act 1914-21
Clayton Act of 1914 exempts unions from anti-trust legislation
Trade union activity rises sharply after WWI
2
Laissez Faire 1922-29
2 Supreme Court rulings in December 1921 invalidate the pro-union
provisions of the Clayton Act
Picketing prohibited and subject to injunction
Trade union activity plummets
Laissez-faire anti-trust policy of Coolidge administration increases
monopoly power
3
Welfare Capitalism 1929-32
Texas & N.O. Railroad case [DC August 1928, CC Appeals June 1929,
Supreme Court May 1930] marks a sea change in labor law
Reversal of a unanimous district and appellate court decision would
have been highly unusual, marking a break with precedent
Increasing pro-union legislative e¤orts in summer/fall 1929
High wage policy of Hoover
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Real Origins of the Great Depression
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Texas & N.O. and Pro-Union Legislation
January - March 1929
Shipstead anti-injunction bill introduced and quickly tabled by the
Senate Judiciary committee due to fears of unconstitutionality.
June 1929
2nd Circuit Court of Appeals upholds pro-union Texas & N.O. ruling.
August 1929
Delegation from Senate Judiciary Committee meets with executive
council of the AFL to propose ’robust’anti-injunction legislation.
October 14 -18, 1929
AFL national convention in Toronto, Senate proposal adopted.
October 21 - 29, 1929
First weakness in stock market, followed by Black Thursday, Black
Monday, Black Tuesday
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Real Origins of the Great Depression
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Contemporary Views
In an article published in the AER 12/30, Edward Berman writes:
“The Supreme Court’s decision in the Texas and N.O.
Railroad case is without doubt one of the most important
rendered in a labor case in many years. Considered as a whole, it
may be regarded as a great victory for organized labor. . . . It
puts the Supreme Court on record in favor of legislation designed
to promote collective bargaining. It promises that the court will,
in the future, be more friendly to state and federal legislation
designed to protect workers from the coercive activities of
anti-union employers. ”
Ohanian emphasizes Hoover’s role in persuading leading industrialists
to implement high wage policy.
Threat of re-unionization if …rms did not o¤er high wages.
Proto-Keynesian idea that high wages would prop up consumption,
averting a "disastrous" recession as in 1920-21.
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Real Origins of the Great Depression
May 2010
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NY Times, October 16, 1929
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Real Origins of the Great Depression
May 2010
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NY Times, October 27, 1929
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Real Origins of the Great Depression
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Model
Monopolistic competition in the goods market
Mortensen-Pissarides search frictions in the labor market
Workers choose to search among …rms of type k 2 fI , C g
Individual =) each worker is marginal worker
Collective =) workers can garner share of pro…ts
Complete asset markets, risk-neutral agents
Productivity growth constant and deterministic
No capital
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Real Origins of the Great Depression
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Agents as Consumers
Risk neutral, no savings
Dixit-Stiglitz preferences over continuum of di¤erentiated goods
Elasticity of substitution across goods
σ
Demand function facing …rm i:
yi =
Ebell/Ritschl (LSE & HU Berlin)
p (yi )
P
σ
Y
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May 2010
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Labor Market Search Frictions
Segmented labor markets k 2 fC , I g
Matching function
1 η
η
m (Uk , Vk ) = mUk Vk
Job-…nding rate
m ( U k , Vk )
1
= mθ k
Uk
η
= f (θ k )
Job-…lling rate
m ( U k , Vk )
η
= mθ k = q (θ k )
Vk
Vk
where labor market tightness θ k
Uk .
Beveridge Curve
Uk f ( θ k ) = ( 1 Uk ) χ
χ
Uk =
χ + f (θ k )
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Real Origins of the Great Depression
May 2010
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Agents as Workers
Value of unemployment in segment k 2 fI , C g
VkU = b +
Value of employment
VkE
1 h
fk VkE 0 + (1
1+r
1 h
= wk +
(1
1+r
fk ) VkU 0
χ) VkE 0
i
+ χVkU 0
where χ is the exogenous separation rate.
i
Worker’s surplus
VkW = wk
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b + β (1
χ
Real Origins of the Great Depression
fk ) VkW 0
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Firms
Value of the …rm
p (yk )
yk
P
VkJ (hk ) = max
vk
wk hk
κvk +
1
V J hk0
1+r
subject to
p (yk )
y
= k
P
Y
technology : yk = Ahk
demand :
hk0 = (1
transition:
1
σ
χ) hk + q (θ k ) vk
wage curve : wk = wk (hk )
Firm’s Euler Equation (labor demand)
κ
1
=
q (θ k )
1+r
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1
σ
σ
Ap yk0
wk0
∂w 0
hk0 0k + (1
∂hk
Real Origins of the Great Depression
κ
χ)
q θ k0
May 2010
!
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Wage Bargaining Regimes
Individual Bargaining
Each worker is treated as marginal worker
Worker’s threat point: Firm loses marginal worker
Bargained wage includes a share of hiring costs
Right-to-Manage Collective Bargaining
Workers form a bargaining coalition
Workers’threat point: Firm shuts down
Bargained wage includes a share of pro…ts
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Real Origins of the Great Depression
May 2010
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Individual Wage Bargaining
Nash bargaining problem
max β ln VIW + (1
wI
β) ln
∂VIJ (hI )
∂hI
IB wage curve
wI = (1
β)
r
σ
VU + β
1+r
σ
1 p (yI )
A
β
P
with slope
∂wI
=
∂hI
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βσ
σσ
1
Ap (y )
β
Real Origins of the Great Depression
May 2010
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Firm’s Euler equation at the steady state (labor demand)
wI =
σ
σ
1 p (yI )
A
β
P
(r + χ )
κ
q (θ I )
Hiring externality (overhiring), interaction between σ and β
κ
σ σ 1 p (yI )
wI + (r + χ)
=
A
q (θ I )
σ β | σ {z P }|{z}
MPL
|
{z
} | {z }
<1
>1 |
employment costs
{z
}
MRP
Hire workers beyond the point at which employment costs covered by
MRP.
Why? Adding a worker depresses the wages of all workers. [Stole and
Zwiebel (AER, REStud 1996)]
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Real Origins of the Great Depression
May 2010
20 / 43
Right-to-Manage Collective Bargaining
Right-to-Manage bargaining problem
max β ln hC VCW
wC
β) ln VCJ
+ (1
CB wage curve
rVCU
β
p (yC )
wC
=
A
1 β
P
|
{z1 + r}
|
worker’s surplus
wC
{z
Ebell/Ritschl (LSE & HU Berlin)
σ
κ
q (θ C )
pro…t per worker
CB labor demand
wC =
χ
(1
σ
β)
Ap (yC )
(r + χ )
Real Origins of the Great Depression
}
κ
q (θ C )
May 2010
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Bargained Wages
Individual Bargaining
wI =
rVIU
β
κ
+
(r + χ )
1+r
1 β
q (θ I )
Collective Bargaining
wC =
rVCU
rVCU
β
κ
+
+
1+r
σ 1 1+r
q (θ C )
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Real Origins of the Great Depression
r
1
β
σ+χ
May 2010
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Equilibrium
Market Clearing when share µ 2 [0, 1] of CB …rms
I = (1
µ)
p (yI )
p (yC )
yI + µ
yC
P
P
Segmented labor markets, workers indi¤erent between searching in I
or C market
rVIU
rVCU
=
1+r
1+r
–> 2 equilibrium conditions in the two unknowns (θ I , θ C ).
Once have equilibrium tightnesses, can easily obtain remaining
variables.
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Real Origins of the Great Depression
May 2010
23 / 43
Quantitative Results
Parameter
A
r
η
β
b/w
χ
κ
Value
1.0
0.01
0.50
0.50
0.30
0.118
0.19
Target
normalization
4% annual r
empirical estimates
Hosios condition
post-war b/w 0.40
BLS data
perf. comp. u = 5.5%
–> all equilibrium variables as functions of (µ, σ)
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Real Origins of the Great Depression
May 2010
24 / 43
Unemployment
Output
0.5
1
Individual
Collective
0.4
0.9
0.3
0.8
0.2
0.7
0.1
0.6
0
0
5
10
15
20
0.5
0
5
Wages
10
15
20
15
20
Profits
1
0.35
0.95
0.3
0.9
0.25
0.85
0.2
0.8
0.15
0.75
0.1
0.7
0.05
0.65
0
5
10
Competition σ
15
20
0
0
5
10
Competition σ
–> need to pin down time series of µ and σ
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Real Origins of the Great Depression
May 2010
25 / 43
Mechanism: Shift towards Collective Bargaining
Collective bargaining wage contains a share of monopoly rents
Total surplus depends on pro…ts, so via wage bargaining, workers’and
…rms’incentives to maximize pro…ts are well-aligned
By …rst principles, monopolistic(ally competitive) pro…ts are maximized
by restricting output below the socially e¢ cient level.
Under collective bargaining, workers take a share of pro…ts roughly
equal to µ –> asset values decline
Real wages increase, employment decreases –> output decreases
Vacancies decrease, tightness increases –> unemployment rises
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Real Origins of the Great Depression
May 2010
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Baseline Scenario
Year
1913-1918
1919
1920
1921
1922-1924
1925-1926
1927
1928
1929
1930
1931-39
σ
4.0
4.0
4.0
4.0
4.0
3.5
3.0
2.5
2.3
2.3
2.3
σ β
1
Markup σ
16.7%
16.7%
16.7%
16.7%
16.7%
20%
25%
33.3%
38.5%
38.5%
38.5%
µ
0
0.25
0.50
0.75
0
0
0
0
0
0.25
0.50
–> σ1913 21 so that ∆µ accounts for 60% of drop in DJ Industrials
–> σ1929 so that ∆µ plus increase in σ accounts for 60% of increase in DJ
Industrials
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Real Origins of the Great Depression
May 2010
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Asset Prices
Dow Jones: Baseline Scenario
260
240
data 1.8pc trend
model
220
200
180
160
140
120
100
80
60
1910
1915
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1920
1925
Real Origins of the Great Depression
1930
1935
1940
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Private Non-Farm GDP
Nonfarm Private GDP: Baseline Scenario
110
data 1.8 pc trend
model
100
90
80
70
60
50
1910
1915
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1920
1925
Real Origins of the Great Depression
1930
1935
1940
May 2010
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Unemployment
Unemployment: Baseline Scenario
0.4
data nonfarm misplaced
data nonfarm
model
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
1910
1915
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1920
1925
Real Origins of the Great Depression
1930
1935
1940
May 2010
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Wages
Wages: Baseline Scenario
120
data
model
115
110
105
100
95
1929
1930
1931
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1932
1933
1934
1935
Real Origins of the Great Depression
1936
1937
1938
1939
May 2010
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Maximal Scenario
Dow Jones: Maximal Scenario
260
240
data 1.8% trend
model
220
200
180
160
140
120
100
80
60
1910
1915
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1920
1925
1930
Real Origins of the Great Depression
1935
1940
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Maximal Scenario
Nonfarm Private GDP: Maximal Scenario
110
data 1.8% trend
model
100
90
80
70
60
50
1910
1915
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1920
1925
Real Origins of the Great Depression
1930
1935
1940
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Maximal Scenario
Unemployment: Maximal Scenario
0.45
0.4
data misplaced
data
model
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
1910
1915
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1920
1925
Real Origins of the Great Depression
1930
1935
1940
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Maximal Scenario
Wages: Maximal Scenario
120
data
model
115
110
105
100
95
1929
1930
1931
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1932
1933
1934
1935
Real Origins of the Great Depression
1936
1937
1938
1939
May 2010
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A Counterfactual
What if Hoover had vigorously enforced anti-trust, reducing the
degree of monopoly power in the economy?
Asset prices would have declined
Incentives to unionize would have been diminished
If switch to CB: less severe recesssion
If stay with IB: no recession, slight expansionary e¤ect
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Real Origins of the Great Depression
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Summary
1
Model accounts well for
Early 1920s recession & stock market crash
Roaring 1920s expansion & stock market boom
Onset of the Great Depression 1929-31
2
Interactions between monopoly power and wage bargaining
3
Crucial di¤erence between individual and collective bargaining is the
threat point
Measures of union membership either overstate or understate
importance of collective bargaining
Legal environment more important
Hanes (2000, AER) …nds that time it took for …rms to reduce wages
after 1929 (during de‡ation) positively correlated with sectoral product
market concentration
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Real Origins of the Great Depression
May 2010
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Individual Wage Bargaining - Details
Nash bargaining problem
max µ ln VIW + (1
wI
µ) ln
∂VIJ (hI )
∂hI
subject to
∂VIJ (hI )
∂hI
VIW
=
1
σ
σ
= wI
Ap (y )
wI
b + β (1
χ
hI
∂wI
+ (1
∂hI
χ)
Φv
q (θ I )
fI ) VIW 0
FOC
wI = (1
µ) b + µ
1
σ
σ
Ap (y )
hI
∂wI
+ (1
∂hI
χ)
Φv
q (θ I )
(1
µ)
(1)
Conjecture:
is independent of hI and wI . Solve …rst-order linear
di¤erential equation (1), then con…rm conjecture.
VIW 0
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Real Origins of the Great Depression
May 2010
38 / 43
Individual Wage Bargaining - Details
FOLDE
wI = (1
µ) b + µ
1
σ
σ
Ap (y )
hI
∂wI
+ (1
∂hI
χ)
Φv
q (θ I )
(1
µ)
Solution to FOLDE
wI = (1
µ) b + µ
σ
σ
1
Ap (y ) + (1
µ
with
∂wI
=
∂hI
(3) into …rm’s Euler equation
hI
1
Φv
=
q (θ )
1+r
σ
σ
µσ
σσ
1
Ap y 0
µ
χ)
Φv
q (θ I )
(1
µ)
1
Ap (y )
µ
w 0 + (1
1
(1
1+r
(2)
(3)
Φv
χ)
q θ0
!
Solve (2) for VIW 0 , substitute back into worker’s surplus
VW =
Ebell/Ritschl (LSE & HU
I Berlin)
µ
σ
1
Ap (y )
w + (1
Real Origins of the Great Depression
I
χ)
Φv
May 2010
39 / 43
Individual Wage Bargaining - Details
(3) into …rm’s Euler equation
Φv
1
=
q (θ )
1+r
σ
σ
1
Ap y 0
µ
w 0 + (1
Φv
χ)
q θ0
!
Solve (2) for VIW 0 , substitute back into worker’s surplus
VIW =
µ
1
µ
σ
σ
1
Ap (y )
µ
wI + (1
χ)
Φv
q (θ I )
One step ahead
1
µ
1
VW0 =
1+r I
1 µ1+r
|
σ
σ
1
Ap y 0
µ
wI0
{z
+ (1
Φv
χ)
q θ I0
Φv /q (θ I )
Future surplus depends only on aggregate variables. Search costs
depend only on aggregate variables.
Wage curve
Ebell/Ritschl (LSE & HU Berlin)
σ
1
Real Origins of the Great Depression
May 2010
!
}
40 / 43
Equilibrium Wages
Individual Bargaining
wI =
rVIU
β
κ
+
(r + χ )
1+r
1 β
q (θ I )
Collective Bargaining
wC =
rVCU
rVCU
β
κ
+
+
1+r
σ 1 1+r
q (θ C )
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Real Origins of the Great Depression
r
1
β
σ+χ
May 2010
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Equilibrium I
Market Clearing, share µ 2 [0, 1] of CB …rms
I = (1
µ)
p (yI )
p (yC )
yI + µ
yC
P
P
Yields the …rst equilibrium condition relating θ I and θ C
A1
σ
= (1
+µ
Ebell/Ritschl (LSE & HU Berlin)
σ
σ
µ)
σ
σ
1 σ
1
κ
β rVIU
+
(r + χ )
1 1+r
1 β
q (θ I )
rVCU
+
1 1+r
1
1
β
Real Origins of the Great Depression
r +χ
κ
q (θ C )
1 σ
May 2010
42 / 43
Equilibrium II
Segmented labor markets, workers indi¤erent between searching in I
or C market
rVCU
rVIU
=
1+r
1+r
Yields a second condition relating θ I and θ C
b+
=
β
1
β
κθ I
r +χ
r +χ
f (θ C ) σ
b+
β
1
f (θ C ) σ
r +χ
β
1
f (θ C ) σ
β
1
κ
q (θ C )
r
1
β
σ+χ
Equilibrium (θ I , θ C ) pinned down for each (µ, σ) pair.
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Real Origins of the Great Depression
May 2010
43 / 43

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