Insiders, Outsiders and Unemployment

by on February 26, 2010 at 10:28 am in Data Source, Economics, Law | Permalink

From today's NYTimes:

The Obama administration is planning to use the government’s enormous buying power to prod private companies to improve wages and benefits for millions of workers, according to White House officials and several interest groups briefed on the plan….

Because nearly one in four workers is employed by companies that have contracts with the federal government, administration officials see the plan as a way to shape social policy and lift more families into the middle class.

At a time of 10% unemployment when real wages need to fall this is bad business cycle policy.  I am more worried, however, about the long term consequences of creating a dual labor market in which insiders with government or government-connected jobs are highly paid and secure while outsiders face high unemployment rates, low wages and part-time work without a career path.

Long-term unemployment is at shockingly high levels which in itself creates a dynamic of persistence because the longer a worker is unemployed the less employable they become (in part due to loss of human capital and signaling problems). Thus, getting these workers back to work is going to be hard enough as it is.  Labor regulations which raise wages and make hiring and firing workers even more costly will make re-employing the long-term unemployed even more difficult.

Moreover, once an economy is in the insider-outsider equilibrium it's very difficult to get out because insiders fear that they will lose their privileges with a deregulated labor market and outsiders focus their political energy not on deregulating the labor market but on becoming insiders–see Blanchard and Summers on hysteresis in unemployment and more recently Larry Ball here.  Many European economies found themselves stuck in the insider-outsider equilibrium and as a result unemployment levels in places like France and Italy hovered at 9% or more for decades.  

Addendum: For a personal perspective see also Eric Raymond today in a post titled Marginal Devolution.  Hat tip on the latter to Arnold Kling who also comments.

1 anon February 26, 2010 at 10:42 am

As if we don’t have enough problems with public sector unions, continuing to prop up the still-too-expensive housing market, the coming tsunami of pension defaults, and looming municipal and state defaults, now this?


Munger is right. Game over.

2 Bill February 26, 2010 at 10:45 am

I think the government should use its contracting authority to check the immigration status of employees, and also to ensure that if contracts are being used to spur employment, it is not going out the backdoor as a foreign outsource contract to India.

As for wages, this seemes to be more limited. From the NYT article:

“In testimony last year to the Office of Management and Budget, Mr. Podesta said that 400,000 workers employed under federal contracts — like cafeteria workers, security guards and landscaping workers at federal buildings — earn less than $22,000 a year, the federal poverty line for a family of four, assuming just one paycheck in a household.”

3 B.B. February 26, 2010 at 10:54 am

I believed President Hoover tried something like this in 1930.

It ended with a political realignment, after chronic high unemployment.

A question to discuss: did the three minimum wage hikes of 2007, 2008, and 2009 contribute to the extra deterioration of the labor market? Hint: teenage unemployment rate is far above 1982 levels.

4 Cosmotarian Overlord February 26, 2010 at 11:14 am

I suppose that Austan Goolsbee and Paul Volcker have never seen these fringe studies that Alex is pointing out. They probably think that is this is just the best way to help out everybody. If only we could show them this article they would probably change their mind! If not them I am sure the Republicans will help fix this problem of a growing government. Guys like Mitt Romney and Scott Brown are really serious about small government this time around.

5 Fully Certified Pussy Hound February 26, 2010 at 11:32 am

“Is there a term we could use for incrased cooperation between big business and government?”

How about fascism?

6 Brett February 26, 2010 at 11:39 am

How about fascism?

“Corporatism” probably describes it better. Think of the 1950s, when a lot of the major industries – particularly in transportation – had extensive regulation, combined with company-union collaboration resulting in oligopolistic labor markets and extensive screwing-over of consumers.

Of course, I’m not sure how far the government could actually push this. Assuming the contracts are both big and long-term, they could probably cut into profit margins (assuming they are there) and the companies could do little (they need the contracts), but if the above isn’t the case, then a potential company could just walk away.

7 Bill February 26, 2010 at 12:26 pm

From an antitrust perspective, this is known as raising rivals costs.

Specifically, if one firm competes for a federal job using employees hired at the federal poverty level, and the rival does not, then the rival hiring at above the poverty level loses the bid.

Do I think this is optimal either way, no. It would probably be better to do an incomes policy targeting those below the poverty level with some income supplement, but, then I am soon supplementing everyone’s income. Might it be optimal to deal with a vendor who has a mix of public and private business, and cause him and his rival to raise costs, say, in service businesses (security, vending, cafeteria, maintenance), where there is no potential loss of business to foreign firms and where the vendor has a mix of private and public business. To bid on the federal or state project, the vendor has to bid with a higher cost; similarly to the private side.

It might be cheaper than an incomes policy to do it this way. Or not. But, it is a debatable, and ultimately, an empirical issue.

8 Richard A. February 26, 2010 at 12:42 pm

If this administration wants to prop up wages for low wage employees, start cracking down on employers who hire illegals. This would increase the demand for domestic workers (US citizens and legal immigrants), causing wages to be higher and unemployment to be lower.

How about making e-verify mandatory across the US?

9 Nelson February 26, 2010 at 12:56 pm

I found Mr. Raymond’s piece terrifingly poignant and insightful. I hope the best for his unlucky friends, but believe he’s probably spot-on in his assessment of their situations.

10 Al Brown February 26, 2010 at 1:24 pm

more artificial measures to create prosperity, which actually only diminish it.

There are no shortcuts. Wealth creation requires an improvement in our ability to produce and even that must outpace competitors to get ahead.

These measures only redistribute wealth temporarily. They fail when jobs get redistributed to places with less stupid policies.

11 John Thacker February 26, 2010 at 1:28 pm

See for example the data here.

Now it’s true that nominal wage rates have rarely fallen in a recession, but adjusted real wage rates almost always do fall in a recession and continue to fall as the hiring picks up.

Just look at how well lower real wages helped recovery from the 2001 recession….

Real wages must fall in a recession. Simply because a recovery is weak doesn’t mean that trying to hold back the tide will actually work. Was the 2001 recession as bad as the Great Depression, where government policy was to hold wages up?

12 Allan February 26, 2010 at 1:43 pm

Mr. Thacker, you include a quote, but not a link. Are you quoting yourself?

And I do not understand how the assembly line required higher wages. What Ford wanted was to keep his highly trained workers on the job. He also wanted to make sure that his workers could afford to buy his product.

Ford could likely have offered wages at a lower level than he did and kept his workers. But he did not. He understood that higher paid workers, on the whole, were better for his company and, incidentally, better for the general economy.

13 James February 26, 2010 at 1:59 pm


You are are that efficiency wages is a classic explanation for long run employment right?

14 Peter February 26, 2010 at 2:03 pm

Allan, he was quoting someone who commented before him on this thread.

As to the issue of whether higher wages (let’s assume taken from company profits) are a net boon to the economy, I’d say they’re at best a wash.

Let’s assume you raised the average wage by 1%, and correspondingly lowered the percentage of profit by the average business by 1%. Let’s further assume that at least for the first year of doing this, a 1% increase in wages and a 1% decrease in profits shakes out to the same amount of money.

Let’s then look at two cases with regard to the Keynesian marginal propensity to consume. In the first case, recipients of business profits (hereafter shareholders, though shareholders are a subset) have an MPC of .3 and a marginal propensity to save of the remainder, i.e. .7 And let wage earners have a MPC of .5 and MPS of .5. Further assume that savings = investment, again on the Keynesian structure.

In this case then, we should expect a small increase in the overall marginal propensity to consume, and a small decrease in the rate of investment. If we did a keynesian cross, we’d see that they cancel each other out perfectly. The effect in observable terms would probably be an increase in demand for consumer goods, which would increase incentive to produce, but simultaneously a lower amount of investable funds and therefore higher interest charged to businesses, lowering the incentive to produce.

So, a wash.

Assuming there are regulatory compliance costs involved with this, (i.e. new paperwork, new bureaus in DC to sort through said paperwork, lawyers to argue about said paperwork, etc.), then the effect would be a mild negative, in the amount of the compliance costs.

Also, the incentive issues discussed by Alex are still prescient as long term effects.

15 alex February 26, 2010 at 2:17 pm

Do you find the argument that the high market share of many American companies (relative to other time periods in US history) provides a persuasive of the job market?

16 Stan February 26, 2010 at 2:30 pm

Andrew Mellon said it better:

“Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate … it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.†

Nice try, Alex, but you’ve been scooped.

17 Mr. E February 26, 2010 at 2:44 pm

Are there any circumstances that a GMU economist would recommend higher wages?


18 Allan February 26, 2010 at 2:50 pm

A bit about Ford and the efficiency of wages theory. Ford was able to pay more because he was able to make a high profit on his product. Ford certainly did not go bankrupt as a result of paying higher wages. Similarly, if he had paid lower wages, he would likely have been richer.

The affect that Ford’s pay policy had was to benefit society. His workers, in aggregate, were able to make purchases that benefitted society more than purchases Ford would have made himself and more than investments by Ford would have benefitted society. Because of his employees’ purchases, other consumers were able to buy more Ford cars. So, it is a circle.

The net creation of wealth effect may well have been zero sum (workers getting more, capitalist (Ford) getting less). But the health of the country benefitted overall.

19 wlu2009 February 26, 2010 at 3:10 pm


By your logic, we could make the whole country better off by legally mandating that every business institute a 10% raise. If you can’t see the flawed logic in that, its not worth the time to explain it.

As to your point about the world not being richer than it was 3000 years ago because all the same stuff is here, thats absurd. Suppose I offered you a brand new car, or a brand new car broken out into all its constituent parts. Which one would make you “richer” by having it. We add value, and therefore wealth, to the economy by putting our labor to things and creating something that is more valuable than the sum of its parts. The world has become more and more efficient at that over time, so we can create more value with less. This is the concept of productivity.

20 Butch February 26, 2010 at 3:27 pm

Social-Democratic/Liberal/Progressive governments don’t solve problems. They create them. What the heck were people thinking when they gave total control of the Executive and Legislative branches to the Democrats.

21 Andrew February 26, 2010 at 3:33 pm

Right, because increasing the amount that taxpayers pay to mow the lawns in D.C. will solve our problems.

Alex, you so silly.

22 wlu2009 February 26, 2010 at 3:53 pm

“Your example does not work. If you gave me a new car, I would be richer, but you would be poorer, for a net economic effect of 0.”

You misread my example. The choice is, which is WORTH more to you. And if I SOLD you a car for a price we both thougth is fair, we would both be richer (why would we voluntarily trade if we didn’t think it led to a net positive for both of us). Or, put differently, if I take a bunch of preexisting car parts, and put them together into a whole car, and my time to do it is worth less to me than the value of the car that I now have, I have created wealth.

In your second point you seem to suggest there is some kind of “hurdle rate” of return on investment after which capitalists should abidacte a % of further returns to labor. I can’t begin to list the myriad problems here, but a big one is that it institutes a huge marginal tax rate on that return in excess of your hurdle rate. Capitalists have less incentive to invest and earn more (by creating more value) if they know more of it will be forced from them and given to others. Keep in mind this excess return is either further invested or spent, both of which create jobs. You are advocating equality over efficiency, and thats fine if you want to make that argument, but don’t make the cardinal sin of claiming there isn’t a trade off between the two.

23 wlu2009 February 26, 2010 at 4:24 pm

Ok, a couple of things:

“But, if the increased value of everything that has made the world is due to labor, should we not value labor more and capitalists (who, by definition, exploit labor) less?”

The savings/investment identity says anyone with any savings at all is a capitalist, so be careful who you throw under the bus. If you have a bank account, its being invested in some asset somewhere.

More importantly, how do the really rich capitalists get rich? Is it not by devoting their labor and intelligence into innovation and invention, thinking of new ways to do things. Nothing is created without labor, even capital. so when you say the increased value of everything is due to labor you may be right, but a lot of that labor was devoted to building capital. You have to get it out of your head that being a capitalist means your a lazy self entitled factory owner.

then you say: “Moreover, if labor is a commodity, which your analysis seems to assume it is, what is the problem with labor regulating how it is used (think unions or government regulation), much as owners of other commodities set the price on their product?”

NOOOO. If all the corn growers colluded to charge one price for corn, that would be illegal and unfair. Sot he same if all the laborers get together and decide to charge a single price for all labor. You are the owner of your labor and can demand the price as you see fit, but collusion is and should be against the rules, just as it is for other commodity owners.

24 Allan February 26, 2010 at 4:43 pm

Wait a second, on your last point.

My point is not that labor should organize in order to raise prices simple because they can. It is that, by organizing, labor (comprised of a number of people) can now compete with “the man” – actually a company composed of a number of investors. If capitalists can increase their bargaining power by organizing into corporations, why can’t labor increase theirs by organizing into unions?

I think I would accept your argument if you concede that the capitalists funding a corporation should have to compete against other capitalists in a corporation for labor and material. But, of course, that would be a ridiculous proposition.

25 Allan February 26, 2010 at 5:31 pm


I am not convinced. I am glad that you agree that unions can be efficient in some cases. I will concede that unions can be inefficient in some cases. I think it relatively relatively rare, however, where unions act against an entire industry, just as it is relatively rare where one corporation controls the entire industry.

I think we can agree that labor is essential to creating value. We can also agree that capital is essential to creating value (in most cases). The question is how much of the increased value (profit) created should go to capitalists and how much to labor.

We might also agree that capitalists have the ultimate ability to apportion the profit from the increased value to labor and capitalists.

Note: I include managerial salaries in labor costs.

Thus, capitalists start off with all of the bargaining power (as it should be). But, without labor, the capitalists have nothing. If labor has no bargaining power, it will continue to have nothing.

Hence unions. I do not dispute that, on occasion (perhaps an understatement) unions have misused what power they have gotten. But capitalists have also misused their power.

We should be clear, however. There is a tension between capitalists and labor on how the increased value (profits) should be apportioned. Without unions, capitalists have the upper hand and can (but not necessarily do) abuse labor.

Somehow, we need to find a way to fairly value labor. If it is going to be based on a market, then labor should be allowed to organize in such a way that it has equal bargaining power.

26 Bernard Yomtov February 26, 2010 at 6:33 pm

I share Alex’s dismay at the fact that insiders can often use their power to enhance their income.

27 Allan February 26, 2010 at 6:51 pm


Labor competition at the lowest level? What a joke. Tell that to my grandmother who worked in a sweatshop on the Lower East Side. If you think that non-monopolist capitalists who ran those shops did not abuse later, I have to wonder. It is a false argument to use as examples highly skilled workers such as computer programmers (some of whom would argue that they are not well-compensated for their work).

Everyone lived in filth because they did not use their resources efficiently, not because there was a lack of wealth.

I do not argue that people on earth are not better off now. I argue that there is a finite amount of wealth out there and the better off we are is not due there being more wealth, but due to a more efficient use of our wealth.

28 Allan February 26, 2010 at 7:55 pm


A great question. But I am not sure I have the answer. My object is to argue for a system that sustains a middle class that can propel the economy. I am not sure how to measure efficiency given that the edges of the middle class would be fuzzy (I would be troubled by having to even define “middle class”).

I would think that we would say the market is most efficient where the middle class benefits sufficiently enough from the increase in value to enable positive growth. It is muddled. I don’t know how to measure it and I am unsure it is that important.

The current system is not efficient, IMHO, because bargaining power is inequitable. But it is more efficient than a system that puts labor at market rates without giving labor (at all levels) the ability to bargain.

29 sraffa February 27, 2010 at 1:34 am

John- Real wages fell in 1981-1982 eh?

1981-01-01 90.056
1982-01-01 91.096
1983-01-01 91.276

Looks like they kept increasing slightly over that period.

Real nonfarm compensation from BLS

July 1981-November 1982 is a recession, so there’s no information there about the recovery.

And even supposing that real wages fell once, is that what we’re going to use to base any theory of the business cycle/business cycle recoveries on? Out of 11 post-war recessions, there’s a lot of things that happened once.

“Real wages must fall in a recession.” They didn’t fall yoy during the 2001 recession, while they fell yoy in Jan 1995, definitely not a recession. There’s so much noise in the real wage numbers, it’s yet another reason to exclude real wage decreases as a serious explanation for business cycle recoveries.

“Simply because a recovery is weak doesn’t mean that trying to hold back the tide will actually work. Was the 2001 recession as bad as the Great Depression, where government policy was to hold wages up”

Real wages rose before, during, and after the 2001 recession. This shows us that, at least for that recession, real wages tell us almost nothing about the dynamics of the recession.

The Great Depression was worse. However, why did other countries experience similar massive depressions without the high wage policy? This high-wage hypothesis is basically one data point. Just like the early 1980s. This line of thinking seems to rely heavily on one data point…..

30 JohnnyE February 27, 2010 at 12:14 pm

You pay people a living wage they end up spending that money on consumer goods and paying taxes. If those Wall Street wizzes were really worried about costs they’d open up the free-market in executive pay. There are plenty of qualified people out there who would be willing to work for half of what they’re paying those leeches. Despite what those ego-driven stars think, nobody in the business world is indispensible, at least that’s what they keep telling their peons. Instaed of “tinkle-down” economics we should have “trickle up” economics. Pay people a living wage, they buy stuff, and everybody makes their profits and bonuses. Then the executives will get paid for how much profits they generated, not for how much they looted their company. How may profit-generating employees did they have to layoff to get enough money for thir bonuses?

31 MnZ February 27, 2010 at 2:15 pm

It is classic Democratic Party constituency building. Democrats are not dumb. They know that bad policy can be used to create special interest groups beholden to the Democratic Party. As long as the benefits are concentrated and the costs are diffused (or hidden), they can create a locked in constituency at little cost to them.

Bad policy? Yes. Destructive over the long term? Of course. But it is how big city machine politics is done and the Democratic Party in Washington is dominated by big city machine politcians.

32 Ronnie Schreiber February 27, 2010 at 3:24 pm

Ford could likely have offered wages at a lower level than he did and kept his workers. But he did not. He understood that higher paid workers, on the whole, were better for his company and, incidentally, better for the general economy.

No, Ford started paying $5/day and he cut the length of the work week precisely because he could not keep his workers. Working in a Ford plant was mind numbing noisy, dirty and dangerous (over 200 Ford workers every year lost fingers or limbs). In 1913 Ford had a 93% employee turnover rate. When your business model is productivity, you need experienced workers, not constantly hiring new employees. Ford also started a company health program including employee clinics around the same time. I believe that if someone demonstrated to Henry Ford that making his plants safer for employees would mean greater productivity, he would have made safety an important company policy.

Wages were going up and the work day and work week were getting shorter long before most of American industrial companies were organized. The UAW didn’t organize the domestic automakers until the mid to late 1930s.

33 Hyphenated American February 27, 2010 at 4:01 pm

I think it was Thomas Sowell who remarked that half of liberal policies can be shown to be wrong by simply acknowledging the law of Supply and Demand.

Higher price for labor – less demand for labor – higher unemployment.

It’s pretty simple. Everything else is commentary.

34 Hyphenated American February 27, 2010 at 4:07 pm

Replying to Alan:

“Ford could likely have offered wages at a lower level than he did and kept his workers. But he did not. He understood that higher paid workers, on the whole, were better for his company and, incidentally, better for the general economy.”

This reminded me of an old Russian joke about a “New Russian” – a constant target of Russian jokes. A “New Russian” is often a term used to describe a corrupt businessman or a ganster, who is trying to show how rich he is.

1st New Russian: I just bought this jacket for $1,000.
2nd New Russian: You are such a clutz. I saw exactly same jacket in the store for $2,000.

Does it make you feel strange that you sound like a character from a Russian joke?

35 Kaleberg February 27, 2010 at 7:04 pm

“At a time of 10% unemployment when real wages need to fall this is bad business cycle policy.”

Why do real wages need to fall. That will just decrease private sector demand further and cut tax revenues. Businesses will grow even more dependent on government hand outs and the government will have less to hand out. Arguing for lower living standards during a recession is counter-productive. Sure, we can ramp down to Argentina and then, maybe Uganda, but that isn’t going to help the unemployment problem or any of the other problems we have to deal with.

36 mulp February 27, 2010 at 10:25 pm

At a time of 10% unemployment when real wages need to fall this is bad business cycle policy.

So, the reason so little demand for goods and services exists, leading to too little demand for labor, is that incomes from labor are too high, leading to too much consumption by workers???

If one thinks lower wages will increase employment, then one must believe wages are way too high in Haiti and wages in Haiti need to fall drastically, say to a nickle a day, in order to boost the Haitian economy into wealth?

37 Charles Collins March 3, 2010 at 4:02 am

I live in Italy. Very high unemployment, especially among the young. However, look in the kitchen of any restaurant, and you will see 5 guys from Bangladesh. Illegal, easily fired, etc. Most Italians do not even have a first job until their late 20’s. This means they never learn a work ethic (especially since attendance is not mandatory at University), and they all live at home with their parents into their 30’s. Not a pretty picture.

38 Kirk March 4, 2010 at 11:04 pm

Prod? is some sort of goverment speak for coerce, bribe, pay off, you know Chicago politics as usual

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