real origins of the great depression - uni-heidelberg.de origins of the great depression monopoly...

Real Origins of the Great DepressionMonopoly Power, Unions and the Interwar Business Cycle

Monique Ebell Albrecht Ritschl

HU Berlin & LSE LSE & CEPR

May 2010

Ebell/Ritschl (LSE & HU Berlin) Real Origins of the Great Depression May 2010 1 / 43

Previous Work on the Interwar Economy

Business Cycle Accounting approach of Chari, Kehoe & McGrattan(2002)

Key role for effi ciency and labor wedgesFocus on Great Depression and aftermath 1929-39Cole & Ohanian (2002) for UK, Hornstein (2002) for Germany,Beaudry & Portiers (2002) for France

Business Cycle Accounting framework

Perfect compeition in goods marketsWalrasian labor markets

Cole and Ohanian (2004)

Explicit modelling of frictionsSpecific to New Deal institutionsFocus on slow recovery from Great Depression 1933 onwards


Our Contributions

1 Scope

Severe recession 1919-21, accompanying stock market crashRecovery to trend 1922-29, stock market boomOnset of the Great Depression 1929-31, stock market crash

2 Explicit modelling of frictions

Interactions between monopoly power and wage bargainingUnemploymentExplanatory power for asset markets

3 History

Identify 3 major shifts in legal environment for organized labor:1914/19, late 1921, 1929Threat point of organized labor strengthened in a series ofdevelopments during 1929, culminating in October 1929


Real Dow Jones Industrial Average, 1913-1939Relative to 1.8% trend

1913 1914 1916 1918 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 19390.0

50.0

100.0

150.0

200.0

250.0

300.0


Real Private Non-Farm Per Capita GDPRelative to 1.8% trend

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 193940

50

60

70

80

90

100

110


The Interwar Business Cycle

NonFarm Unemployment 19131939

0

5

10

15

20

25

30

35

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


Real Wages in Manufacturing, 1929-1939Relative to 1.8% trend, deflated by PPI

1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939

0.900

0.950

1.000

1.050

1.100

1.150

1.200


Interwar Labor Law Regimes

1 Clayton Act 1914-21Clayton Act of 1914 exempts unions from anti-trust legislationTrade union activity rises sharply after WWI

2 Laissez Faire 1922-292 Supreme Court rulings in December 1921 invalidate the pro-unionprovisions of the Clayton ActPicketing prohibited and subject to injunctionTrade union activity plummetsLaissez-faire anti-trust policy of Coolidge administration increasesmonopoly power

3 Welfare Capitalism 1929-32Texas & N.O. Railroad case [DC August 1928, CC Appeals June 1929,Supreme Court May 1930] marks a sea change in labor lawReversal of a unanimous district and appellate court decision wouldhave been highly unusual, marking a break with precedentIncreasing pro-union legislative efforts in summer/fall 1929High wage policy of Hoover


Texas & N.O. and Pro-Union Legislation

January - March 1929Shipstead anti-injunction bill introduced and quickly tabled by theSenate Judiciary committee due to fears of unconstitutionality.

June 19292nd Circuit Court of Appeals upholds pro-union Texas & N.O. ruling.

August 1929Delegation from Senate Judiciary Committee meets with executivecouncil of the AFL to propose ’robust’anti-injunction legislation.

October 14 -18, 1929AFL national convention in Toronto, Senate proposal adopted.

October 21 - 29, 1929First weakness in stock market, followed by Black Thursday, BlackMonday, Black Tuesday


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 importantrendered in a labor case in many years. Considered as a whole, itmay be regarded as a great victory for organized labor. . . . Itputs the Supreme Court on record in favor of legislation designedto promote collective bargaining. It promises that the court will,in the future, be more friendly to state and federal legislationdesigned to protect workers from the coercive activities ofanti-union employers. ”

Ohanian emphasizes Hoover’s role in persuading leading industrialiststo implement high wage policy.Threat of re-unionization if firms did not offer high wages.Proto-Keynesian idea that high wages would prop up consumption,averting a "disastrous" recession as in 1920-21.


NY Times, October 16, 1929


NY Times, October 27, 1929


Model

Monopolistic competition in the goods market

Mortensen-Pissarides search frictions in the labor market

Workers choose to search among firms of type k ∈ {I ,C}Individual =⇒ each worker is marginal workerCollective =⇒ workers can garner share of profits

Complete asset markets, risk-neutral agents

Productivity growth constant and deterministic

No capital


Agents as Consumers

Risk neutral, no savings

Dixit-Stiglitz preferences over continuum of differentiated goods

Elasticity of substitution across goods −σ

Demand function facing firm i :

yi =(p (yi )P

)−σ

Y


Labor Market Search Frictions

Segmented labor markets k ∈ {C , I}Matching function

m (Uk ,Vk ) = mUηkV

1−ηk

Job-finding rate

m (Uk ,Vk )Uk

= mθ1−ηk = f (θk )

Job-filling ratem (Uk ,Vk )

Vk= mθ

−ηk = q (θk )

where labor market tightness θk ≡ VkUk.

Beveridge CurveUk · f (θk ) = (1− Uk ) χ

Uk =χ

χ+ f (θk )


Agents as Workers

Value of unemployment in segment k ∈ {I ,C}

V Uk = b+1

1+ r

[fkV

E ′k + (1− fk )V U ′k

]Value of employment

V Ek = wk +1

1+ r

[(1− χ)V E ′k + χV U ′k

]where χ is the exogenous separation rate.

Worker’s surplus

VWk = wk − b+ β (1− χ− fk )VW ′k


Firms

Value of the firm

V Jk (hk ) = maxvk

{p (yk )P

yk − wkhk − κvk +1

1+ rV J(h′k)}

subject to

demand :p (yk )P

=(ykY

)− 1σ

technology : yk = Ahktransition: h′k = (1− χ) hk + q (θk ) vkwage curve : wk = wk (hk )

Firm’s Euler Equation (labor demand)

κ

q (θk )=

11+ r

(σ− 1

σAp(y ′k)− w ′k − h′k

∂w ′k∂h′k

+ (1− χ)κ

q(θ′k))


Wage Bargaining Regimes

Individual Bargaining

Each worker is treated as marginal workerWorker’s threat point: Firm loses marginal workerBargained wage includes a share of hiring costs

Right-to-Manage Collective Bargaining

Workers form a bargaining coalitionWorkers’threat point: Firm shuts downBargained wage includes a share of profits


Individual Wage Bargaining

Nash bargaining problem

maxwI

β lnVWI + (1− β) ln∂V JI (hI )

∂hI

IB wage curve

wI = (1− β)r

1+ rV U + β

σ− 1σ− β

Ap (yI )P

with slope∂wI∂hI

= −β

σ

σ− 1σ− β

Ap (y)


Firm’s Euler equation at the steady state (labor demand)

wI =σ− 1σ− β

Ap (yI )P− (r + χ)

κ

q (θI )

Hiring externality (overhiring), interaction between σ and β

wI + (r + χ)κ

q (θI )︸︷︷︸employment costs

=σ

σ− β︸︷︷︸>1

σ− 1σ

p (yI )P︸︷︷︸

<1

A︸︷︷︸MPL︸︷︷︸

MRP

Hire workers beyond the point at which employment costs covered byMRP.

Why? Adding a worker depresses the wages of all workers. [Stole andZwiebel (AER, REStud 1996)]


Right-to-Manage Collective Bargaining

Right-to-Manage bargaining problem

maxwC

β ln(hCV

WC

)+ (1− β) lnV JC

CB wage curve

wC −rV UC1+ r︸︷︷︸

worker’s surplus

=β

1− β

[Ap (yC )P− wC − χ

κ

q (θC )

]︸︷︷︸

profit per worker

CB labor demand

wC =σ− (1− β)

σAp (yC )− (r + χ)

κ

q (θC )


Bargained Wages


wI =rV UI1+ r

+β

1− β(r + χ)

κ

q (θI )

Collective Bargaining

wC =rV UC1+ r

+β

σ− 1

[rV UC1+ r

+κ

q (θC )

(r

1− βσ+ χ

)]


Equilibrium

Market Clearing when share µ ∈ [0, 1] of CB firms

I = (1− µ)p (yI )P

yI + µp (yC )P

yC

Segmented labor markets, workers indifferent between searching in Ior C market

rV UI1+ r

=rV UC1+ r

—> 2 equilibrium conditions in the two unknowns (θI , θC ).

Once have equilibrium tightnesses, can easily obtain remainingvariables.


Quantitative Results

Parameter Value TargetA 1.0 normalizationr 0.01 4% annual rη 0.50 empirical estimatesβ 0.50 Hosios conditionb/w 0.30 post-war b/w ≥ 0.40

χ 0.118 BLS dataκ 0.19 perf. comp. u = 5.5%

—> all equilibrium variables as functions of (µ, σ)


0 5 10 15 200.5

0.6

0.7

0.8

0.9

1Output

0 5 10 15 20

0.65

0.7

0.75

0.8

0.85

0.9

0.95

1

Competition σ

Wages

0 5 10 15 200

0.05

0.1

0.15

0.2

0.25

0.3

0.35

Competition σ

Profits

0 5 10 15 200

0.1

0.2

0.3

0.4

0.5Unemployment

IndividualCollective

—> need to pin down time series of µ and σ


Mechanism: Shift towards Collective Bargaining

Collective bargaining wage contains a share of monopoly rents

Total surplus depends on profits, so via wage bargaining, workers’andfirms’incentives to maximize profits are well-alignedBy first principles, monopolistic(ally competitive) profits are maximizedby restricting output below the socially effi cient level.

Under collective bargaining, workers take a share of profits roughlyequal to µ —> asset values decline

Real wages increase, employment decreases —> output decreases

Vacancies decrease, tightness increases —> unemployment rises


Baseline Scenario

Year σ Markup σ−βσ−1 µ

1913-1918 4.0 16.7% 01919 4.0 16.7% 0.251920 4.0 16.7% 0.501921 4.0 16.7% 0.751922-1924 4.0 16.7% 01925-1926 3.5 20% 01927 3.0 25% 01928 2.5 33.3% 01929 2.3 38.5% 01930 2.3 38.5% 0.251931-39 2.3 38.5% 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 DJIndustrialsEbell/Ritschl (LSE & HU Berlin) Real Origins of the Great Depression May 2010 27 / 43

Asset Prices

1910 1915 1920 1925 1930 1935 1940

60

80

100

120

140

160

180

200

220

240

260Dow Jones: Baseline Scenario

data 1.8pc trendmodel


Private Non-Farm GDP

1910 1915 1920 1925 1930 1935 194050

60

70

80

90

100

110Nonfarm Private GDP: Baseline Scenario

data 1.8 pc trendmodel


Unemployment

1910 1915 1920 1925 1930 1935 19400

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4Unemployment: Baseline Scenario

data nonfarm misplaceddata nonfarmmodel


Wages

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 193995

100

105

110

115

120Wages: Baseline Scenario

datamodel


Maximal Scenario

1910 1915 1920 1925 1930 1935 1940

60

80

100

120

140

160

180

200

220

240

260Dow Jones: Maximal Scenario

data 1.8% trendmodel


Maximal Scenario

1910 1915 1920 1925 1930 1935 194050

60

70

80

90

100

110Nonfarm Private GDP: Maximal Scenario

data 1.8% trendmodel


Maximal Scenario

1910 1915 1920 1925 1930 1935 19400

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45Unemployment: Maximal Scenario

data misplaceddatamodel


Maximal Scenario

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 193995

100

105

110

115

120Wages: Maximal Scenario

datamodel


A Counterfactual

What if Hoover had vigorously enforced anti-trust, reducing thedegree of monopoly power in the economy?

Asset prices would have declinedIncentives to unionize would have been diminishedIf switch to CB: less severe recesssionIf stay with IB: no recession, slight expansionary effect


Summary

1 Model accounts well for

Early 1920s recession & stock market crashRoaring 1920s expansion & stock market boomOnset of the Great Depression 1929-31

2 Interactions between monopoly power and wage bargaining3 Crucial difference between individual and collective bargaining is thethreat point

Measures of union membership either overstate or understateimportance of collective bargainingLegal environment more importantHanes (2000, AER) finds that time it took for firms to reduce wagesafter 1929 (during deflation) positively correlated with sectoral productmarket concentration


Individual Wage Bargaining - Details

Nash bargaining problem

maxwI

µ lnVWI + (1− µ) ln∂V JI (hI )

∂hI

subject to

∂V JI (hI )∂hI

=σ− 1

σAp (y)− wI − hI

∂wI∂hI

+ (1− χ)Φv

q (θI )

VWI = wI − b+ β (1− χ− fI )VW ′I

FOC

wI = (1− µ) b+µ

[σ− 1

σAp (y)− hI

∂wI∂hI

+ (1− χ)Φv

q (θI )

]− (1− µ) β (1− χ− fI )VW ′I

(1)Conjecture: VW ′I is independent of hI and wI . Solve first-order lineardifferential equation (1), then confirm conjecture.



FOLDE

wI = (1− µ) b+µ

[σ− 1

σAp (y)− hI

∂wI∂hI

+ (1− χ)Φv

q (θI )

]− (1− µ) β (1− χ− fI )VW ′I

Solution to FOLDE

wI = (1− µ) b+µ

[σ− 1σ− µ

Ap (y) + (1− χ)Φv

q (θI )

]− (1− µ)

11+ r

(1− χ− fI )VW ′I

(2)with

hI∂wI∂hI

= −µ

σ

σ− 1σ− µ

Ap (y) (3)

(3) into firm’s Euler equation

Φv

q (θ)=

11+ r

(σ− 1σ− µ

Ap(y ′)− w ′ + (1− χ)

Φv

q(θ′))

Solve (2) for VW ′I , substitute back into worker’s surplus

VWI =µ

1− µ

(σ− 1σ− µ

Ap (y)− wI + (1− χ)Φv

q (θI )

)Ebell/Ritschl (LSE & HU Berlin) Real Origins of the Great Depression May 2010 39 / 43


(3) into firm’s Euler equation

Φv

q (θ)=

11+ r

(σ− 1σ− µ

Ap(y ′)− w ′ + (1− χ)

Φv

q(θ′))

Solve (2) for VW ′I , substitute back into worker’s surplus

VWI =µ

1− µ

(σ− 1σ− µ

Ap (y)− wI + (1− χ)Φv

q (θI )

)One step ahead

11+ r

VW ′I =µ

1− µ

11+ r

(σ− 1σ− µ

Ap(y ′)− w ′I + (1− χ)

Φv

q(θ′I))︸︷︷︸

Φv/q(θI )

Future surplus depends only on aggregate variables. Search costsdepend only on aggregate variables.Wage curve

wI = (1− µ) b+ µ

[σ− 1σ− µ

Ap (y) +Φv θI

]Ebell/Ritschl (LSE & HU Berlin) Real Origins of the Great Depression May 2010 40 / 43

Equilibrium Wages


wI =rV UI1+ r

+β

1− β(r + χ)

κ

q (θI )

Collective Bargaining

wC =rV UC1+ r

+β

σ− 1

[rV UC1+ r

+κ

q (θC )

(r

1− βσ+ χ

)]


Equilibrium I

Market Clearing, share µ ∈ [0, 1] of CB firms

I = (1− µ)p (yI )P

yI + µp (yC )P

yC

Yields the first equilibrium condition relating θI and θC

A1−σ = (1− µ)

{σ− β

σ− 1

[rV UI1+ r

+1

1− β(r + χ)

κ

q (θI )

]}1−σ

+µ

{σ

σ− 1

[rV UC1+ r

+

(1

1− βr + χ

)κ

q (θC )

]}1−σ


Equilibrium II

Segmented labor markets, workers indifferent between searching in Ior C market

rV UI1+ r

=rV UC1+ r

Yields a second condition relating θI and θC

b+β

1− βκθI

=r + χ

r + χ− f (θC ) βσ−1

b+f (θC )

βσ−1

r + χ− f (θC ) βσ−1

κ

q (θC )

(r

1− βσ+ χ

)Equilibrium (θI , θC ) pinned down for each (µ, σ) pair.


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