Download Worker Insecurity and US Macroeconomic Performance

Review of Radical Political Economics
10.1177/0486613404272631
Setterfield // Spring
U.S. Macroeconomic
2005
Performance in the 1990s
Worker Insecurity and U.S.
Macroeconomic Performance
During the 1990s
MARK SETTERFIELD
Trinity College, Department of Economics, 300 Summit Street, Hartford,CT 06106-3100, USA;
e-mail: [email protected]
Received March 17, 2003; accepted January 15, 2004
Abstract
A model of macroeconomic outcomes is developed in which money and aggregate demand matter, inflation is the outcome of conflicting nominal income claims, and institutions create relatively enduring
“conditional closures” in otherwise open macroeconomic processes. This model is used to hypothesize
that U.S. macroeconomic performance during the late 1990s resulted from a combination of relaxed monetary policy and the consolidation of institutional changes in the U.S. labor market that, by the late 1990s,
rendered workers’ employment and income prospects insecure. Empirical results confirm that increased
worker insecurity contributes to explaining U.S. inflation since 1973, and that by the 1990s, the inflation
costs of any given rate of unemployment in the United States had been reduced. It is suggested that the
supply side of the U.S. economy may now be capable of sustaining low unemployment and inflation
outcomes, primarily as a result of labor market institutions that have “zapped” U.S. labor.
JEL classification: E1, E6
Keywords:
inflation; Phillips curve; unemployment; worker insecurity
1. Introduction
During the late 1990s, the rate of unemployment in the United States dropped to a
thirty-year low without causing any increase in inflation. In fact, the rate of inflation actually fell over time, even as the rate of unemployment was itself falling. Comparing the periods 1990-95 and 1996-2000 reveals that as the average annual rate of unemployment in the
United States decreased from 6.4 to 4.6 percent, the average annual rate of inflation fell
from 3.3 to 2.4 percent.1
1. Economic Report of the President (2002: 370, 393).
Author’s Note: I would like to thank, without implicating, Wendy Cornwall, Gary Dymski, Bruce
Pietrykowski, Gil Skillman, and participants in the CEMF/ADEK conference at the Université de Bourgogne,
Dijon, in November 2002 for comments on an earlier version of this article.
Review of Radical Political Economics, Volume 37, No. 2, Spring 2005, 155-177
DOI: 10.1177/0486613404272631
© 2005 Union for Radical Political Economics
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These outcomes provide a puzzle for mainstream macroeconomics, according to which
the configuration of the real economy is unaffected by monetary variables (at least in the
long run) and is determined by a unique, supply-determined labor market equilibrium represented by either the natural rate of unemployment or non-accelerating inflation rate of unemployment (NAIRU). In the mid-1990s, the value of the NAIRU in the United States was
commonly reputed to be about 6 percent (Ball and Moffitt 2001: 1). According to the mainstream view, then, as the actual rate of unemployment in the United States fell lower than 6
percent (as it had done by 1995), inflation should have begun to increase continuously.
One popular view among mainstream economists that has emerged in response to this
situation is that during the 1990s, the U.S. economy was subjected to favorable supply
shocks that shifted the position of the short-run Phillips curve, permitting a temporary reduction in the rate of unemployment lower than the NAIRU without any increase in inflation. These favorable supply shocks purportedly include the behavior of commodity prices,
employer-financed health care contributions, and an increase in the productivity growth rate
in excess of the rate of growth of workers’ real wage aspirations (Gordon 1998; Ball and
Moffitt 2001). According to this modified mainstream view, the U.S. economy must eventually sacrifice either the low unemployment or the low inflation experienced during the late
1990s as the benefits of favorable supply shocks dissipate.2
The purpose of this article is to present an alternative to the mainstream, NAIRU-based
account of U.S. macroeconomic outcomes during the 1990s and an alternative prognosis for
the U.S. economy. These alternatives are based on a model that differs from mainstream
NAIRU analysis in three crucial respects:
1. Monetary variables (including those under the control of policy makers) are nonneutral even
in the long run and influence the position of the demand-determined equilibrium that charac3
terizes the configuration of the economy as a whole.
2. Value and distribution (as reflected by the real wage) are determined as the outcomes of a sequential-recursive process of wage and price setting in which workers and firms bargain over
the value of the nominal wage and firms set prices as a markup over average direct costs in accordance with the degree of monopoly they exercise in product markets. It follows that inflation is (at least in part) the product of the conflicting nominal income claims that are manifest
in this wage- and price-setting process rather than being solely due to an excess demand for
goods.
3. The economy is characterized by durable but ultimately mutable institutional macrofoundations rather than “natural laws” of motion. These institutional macrofoundations
create an “operating system” in the context of which decisions are made and behavior takes
place, and as a result of which the economy is rendered “conditionally stable” for discrete periods (Crotty 1994). They lend structure to (among other things) the wage- and price-setting
process, creating discrete periods of “conditional closure” in otherwise open macroeconomic
2. Some authors argue that, in addition to the favorable supply shocks mentioned above, U.S. macroeconomic performance during the late 1990s benefitted from a reduction in the NAIRU itself (see, e.g., Gordon
1998). In this case, only some part of the total reduction in unemployment achieved during the late 1990s (specifically, that part associated with the effects of temporary supply shocks) need be sacrificed in the future to the
goal of stable inflation.
3. The possibility that deficient demand in the form of too little investment spending by firms can create a
binding supply constraint associated with a shortage of capital is overlooked in what follows, because it is not
deemed applicable in the U.S. case.
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INCOME GENERATING PROCESS characterised by non-neutrality of money, chronic effective
demand problems
↓
Solution—use of discretionary macro policy to
manipulate level of demand in order to keep economy close to full utilization of resources.
↓
But VALUE AND DISTRIBUTION based on
conflicting nominal income claims, giving rise to
Kalecki’s political consequences of full employment (FE)—reduced unemployment increases the
relative bargaining power (RBP) and/or real wage
aspirations of labor, resulting in pressure on profits
(redistribution of income towards wages) and/or
inflation.
↓
↓
SOLUTION #1
SOLUTION #2*
“Cold bath”—renege on solution to problems of
income-generating process, depress demand so
that RBP and/or aspirations of workers fall and
pressure on profit share/inflation is relaxed.
RESULT—periodic resort to an “incomes policy
based on fear,” in which fear is created by labor
market outcomes (specifically, unemployment).
LIMPING PROSPERITY (e.g., 1973-89)
Devise macroinstitutional framework (IF) to
finesse increased RBP/aspirations of workers by
building consensus around mutually acceptable
“fair”distribution of outcomes. Involves committing to FE and high/growing wages in return for
reciprocal commitment to maintenance of profitability, as under the post-war “capital-labor
accord” (Bowles, Gordon, and Weisskopf, 1990).
RESULT—institutional closure based on norm of
“value sharing”; FE can now be achieved without
pressure on profit share/inflation. EGALITARIAN
PROSPERITY (e.g., the GoldenAge, 1945-73).
SOLUTION #3*
Devise macro IF that reduces the RBP/aspirations of workers by “zapping labor” and enables imposition of
firms’ preferred profit share/stable inflation. Involves anti-union labor laws, downsizing, changes in employment
relationship (e.g., increased nonstandard employment), capital mobility, etc., designed to create worker insecurity. RESULT—institutional closure based on “winner takes all” norm, manifest in an “incomes policy based on
fear” in which fear is created by the structure of the labor market rather than a specific labour market outcome
(unemployment); FE can now be achieved without pressure on profit share/inflation. NEOLIBERAL
PROSPERITY (e.g., United States, 1990s?)
*
In both solution #2 and solution #3, conditional closure is based on institutions that (temporarily) “solve” the
conflict inherent in the determination of value and distribution and thus reconcile FE with stable income shares
and inflation.
Figure 1.
Effective Demand, Inflation, and Institutional Closure
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processes (Setterfield 2003a). Situations of conditional stability and closure in turn give rise
to provisional or conditional equilibria (Chick and Caserta 1997; Setterfield 1997; Chick
2002).
In other words, the economy is characterized by an income-generating process that is fundamentally monetary and demand-determined; conflict and power are central to the determination of value and distribution, and hence inflation; and social institutions create relatively enduring conditional closures in an otherwise open system. These conditional
closures give rise to discrete “episodes” of better or worse macroeconomic performance,
each of which possesses a distinct “character” defined in terms of the distribution of power
and income. The precise relationship among these postulates—which will be immediately
familiar to students of post-Keynesian, social structure of accumulation, and regulation theories of the aggregate economy—is captured in the macroeconomic schema in Figure 1 and
again in the formal model developed in section 2. Central to the discussion that follows is
the hypothesis that since the 1970s, a new institutional framework has emerged in the U.S.
labor market that has created a new conditional closure in the wage- and price-setting process capable of supporting simultaneously low rates of unemployment and inflation. In tandem with monetary policy and the workings of the monetary and demand-determined income-generating process, this explains both U.S. macroeconomic performance during the
1990s and the potential (at least on the supply side) for this performance to be sustained
throughout the coming decade.
The remainder of the article is organized as follows. In section 2, a model is developed
that is consistent with the broad vision of the macroeconomic process outlined above. The
hypothesis concerning institutional change and U.S. macroeconomic performance is tested
in the following section. Finally, section 3 offers some conclusions.
2. A Model of Short-Run Macroeconomic Outcomes
The model developed in this section provides a stylized account of macroeconomic outcomes that is ultimately designed to focus attention on the supply-side relationship among
institutions, the macroeconomics of the wage bargain, and the possibilities for reconciling
low rates of unemployment with low rates of inflation. In so doing, it abstracts from two important themes in heterodox macroeconomics regarding the distribution of income: the idea
that income distribution is an important determinant of aggregate demand, and the notion
that labor market institutions and/or the level of employment influence the distribution of
income itself.4 It is also an aggregate model in which no attempt is made to distinguish
among sectors of a segmented labor market in which workers may be differently affected by
changes in labor market institutions and/or the general level of economic activity.
2.1. The Demand Side
Aggregate income (Y) in any given period is determined by the volume of aggregate demand (D) in an economy that is never characterized by the full use of productive resources.
4. These omissions are discussed further in section 2.4 (below).
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Aggregate demand, meanwhile, is conceived as consisting of endogenous and autonomous
components, the latter (associated in this model with capital-account expenditures by
households and firms) influenced by the rate of interest and the state of long-run expectations. Aggregate demand can therefore be written as
D = D1 ( D−1 ) + D2 ( r, e), D1/ > 0, D2 r < 0, D2 e > 0
where r is the nominal interest rate, e = e(E) is a shift parameter with a value determined by
the state of long-run expectations (E), Dij denotes the partial derivative of function Di with
respect to variable j, and the endogenous component of demand is financed by the previous
period’s income (Y–1 = D–1). Linearizing this function, we arrive at
D = θ1 D − 1 + θ 2 e − θ 3 r
or, for D = D–1:
D=
1
(θ 2 e* − θ 3 r)
1 − θ1
(1)
Equation 1 is rendered conditionally closed here by the assumption of a constant state of
long-run expectations E* (so that e = e* = e[E*]).
2.2. The Supply Side
The level of economic activity in this model is demand determined, with supply adjusting to demand through variations in the utilization rates of productive resources. Hence, we
can write:
U = U ( D), U / < 0
(2)
where U is the rate of unemployment. At the same time, variations in the unemployment
rate affect the wage- and price-setting process. For example, a reduction in the rate of unemployment that enhances the relative bargaining power of labor in the wage bargain may
cause nominal wages to grow faster than productivity. If firms are unwilling to allow nominal income to be redistributed toward labor and have the power to increase prices in product
markets, this increase in unit labor costs will cause price inflation. This is captured by the
following equations describing wage- and price-setting behavior.5
(w − p) T = α − γU + λ (δq + (1 − δ) a) − φS
(3)
w = µ(w − p) T + βp e
(4)
5. The wage- and price-setting equations described here can, under different hypotheses about the size of certain key parameters, accommodate a variety of different mainstream and heterodox interpretations of the macroeconomics of the wage bargain. Ultimately, this is testimony to the flexibility of the Phillips curve as an organizing concept in macroeconomic modeling. As will become clear—especially in section 3—this feature of the
model ultimately facilitates examination of the links between institutions and recent U.S. unemployment and inflation performance in a way that allows us to encompass popular mainstream explanations of the same performance that focus on transitory supply shocks.
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(5)
p = τ+w − q
e
Where w is the rate of growth of nominal wages, p and p are the actual and expected rates of
inflation respectively, q is the rate of growth of productivity, a is a distributed lag of past
rates of growth of the real wage, and τ represents the rate of growth of the gross markup (the
ratio of price to unit labor costs). Finally, S is an index of the willingness and ability of
workers to press for nominal wage increases. More specifically, this variable captures the
impact of the institutional structure of the labor market—the conventions and laws that
shape the type of employment offered, commitment of firms to current employees, attitudes
toward trade unions, and so on—on both the extent of and the propensity of workers to act
on the relative power of labor in the wage bargain at any given rate of unemployment. It allows us to entertain the notion that, as intimated in Figure 1, the institutional structure of the
labor market can ameliorate inflation in either one of two ways. First, workers and firms can
enter into a social bargain involving mutual commitment to a “fair” distribution of income.
In this case, the social bargain reduces workers’ willingness to act on their bargaining
power, which tempers nominal wage growth and hence, ceteris paribus, inflation. This situation was characteristic of the advanced capitalist economies during the postwar Golden
Age (Cornwall 1990; Bowles, Gordon, and Weisskopf 1990). Second, firms (aided by the
state) can unilaterally impose their preferred distributional outcomes on workers by creating a labor market environment in which workers’ employment and income prospects are
rendered insecure. In this case, the institutional structure of the labor market acts as a
worker discipline device, reducing workers’ relative bargaining power and hence their ability to pursue nominal wage increases. Again, the result is that both nominal wage growth
and, ceteris paribus, inflation will be tempered. The central hypotheses of this article are
that, since the breakdown of the postwar social bargain circa 1973: (1) S has essentially become an index of worker insecurity, and (2) increases in the value of S culminating in the
1990s have contributed to the capacity of the U.S. economy to sustain low rates of unemployment without increasing inflation during the late 1990s by acting as a substitute for the
disciplinary effects of high unemployment.6
Equation 3 describes workers’ target rate of growth of real wages, (w – p)T, which is determined by factors affecting both the extent of and workers’ willingness to act on their relative bargaining power (U and S), together with workers’ real wage growth aspirations. Real
wage growth aspirations are modeled as a weighted average of the current rate of productivity growth and a distributed lag of past rates of growth of the real wage, the latter represent6. These hypotheses have been entertained else—wheremost famously, perhaps, by Alan Greenspan in his
so-called labor market fear factor testimony before the U.S. Senate (Greenspan 1997). More recently, Krugman
(2002) has commented on the increased riskiness that confronts workers arising from changes in norms of compensation and corporate behavior, suggesting that
much more than economists and free-market advocates like to imagine, wages . . . are determined by
social norms. What happened during the 1930s and 1940s was that new norms of equality were established, largely through the political process. What happened in the 1980s and 1990s was that those
norms unraveled, replaced by an ethos of anything goes.
7. The size of β is a key point of contention between mainstream and heterodox macroeconomics. Hence, if
β = 1, the model developed above is consistent with the existence of a unique, supply-determined NAIRU. See,
however, Fair (2000) and Setterfield and LeBlond (2003) for evidence supporting the view taken here that β < 1.
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ing the “reference transactions” on which aspirations are commonly based (see Ball and
Moffitt 2001: 4). It is assumed, however, that there may also be subjective influences on aspirations—hence λ ≠ 1. In equation 4, which describes the rate of growth of nominal wages,
we expect to observe µ, β < 1.7 In other words, it is not assumed that workers are automatically able to fully index either their target rate of growth of real wages or their inflation expectations into the actual rate of growth of nominal wages. Finally, equation 5 suggests that
inflation depends on the excess of nominal wage growth over the rate of productivity growth
and the behavior of the gross markup. This equation can be thought of as having been derived from a cost-plus pricing equation of the simple form in which prices are determined as
a markup over unit labor costs (see, e.g., Lavoie 1992: ch. 3).8 It is possible to think of τ as a
“residual” variable that captures the net effect of all influences on the rate of inflation other
than the growth of unit labor costs.9 Note also that, from the perspective of cost-plus pricing
theory, the assumption that τ ≠ 0 is consistent with the hypothesis that firms, via their pricing policies, are active rather than passive participants in the inflation process. That is,
changes in the rate of growth of unit labor costs are not the sole factor responsible for initiating inflation: factors such as adjustments to the markup designed to enhance the profit share
can also play this role.
Substituting 3 into 4 and then the resulting expression into 5, we arrive at the following:
p = µα + βp e − µγU + τ + (µλδ − 1) q + µλ (1 − δ) a − µφS
(6)
which is essentially a short-run Phillips curve (SRPC). If we now allow for inflation expectations to be realized and impose on variables other than p and U constant episodic values—that is, trend values that are assumed to endure for a discrete macroeconomic episode—we arrive at the following:10
p=
1
(µα − µγU + (1 − µλ (1 − δ)) τ E − (1 − µλ ) q E − µϕS E )
1−β
(7)
Equation 7 constitutes an episodic Phillips curve (EPC) rather than a long-run Phillips
curve, which is conventionally associated with steady state equilibrium conditions and is
thus considered a “final” position. The methodology used in the construction of the model
developed here does not admit the existence of “final” positions. Instead, all equilibria are
deemed temporary in the sense that they are conditional on a set of ceteris paribus conditions and/or relatively enduring conventions. In equation 7, for example, coefficients such
8. Mainstream authors also make use of aggregate pricing equations similar to equation 5 but prefer to think
of them as being derived from the definition of the wage share of income rather than as behavioral equations
(see, e.g., Gordon 1998; Ball and Moffitt 2001). Again, this capacity to support alternative interpretations is testimony to the plasticity of the model of aggregate wage and price setting developed above.
9. A ubiquitous feature of mainstream, NAIRU-based interpretations of U.S. performance during the 1990s
is that the temporarily favorable behavior of τ (rather than the enduring influence of S on the growth of unit labor
costs) accounts for a significant part of the reduction in inflation at low rates of unemployment experienced by
the United States.
10. Note that the variable a achieves its constant episodic value when it converges to the current constant episodic value of the real wage growth rate. On the basis of equation 5, the latter is given by the following:
( w − p )E = q E − τ E
This information is incorporated into the solution of equation 7.
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as λ and µ are capable of change in principle but are held constant by a set of ceteris paribus
assumptions that are designed to focus attention on the interaction of other variables in the
model. Meanwhile, the episodic value of the variable S depends on a set of relatively enduring (but ultimately mutable) institutional arrangements that define the structure of the employment relationship, the status of trade unions in the economy, and so forth. Note that in
equation 7, τ is assumed to have an episodic value (τE) that may be nonzero. This means that
the macroeconomic episode with which the Phillips curve in equation 7 is associated may
involve changes in the wage and profit shares of income (because the gross markup is inversely related to the wage share). This provides a clear illustration of the difference between an episodic and a conventional long-run Phillips curve, because under steady state
conditions, we must observe τ = 0 since the wage share is a bounded variable. Note, however, that a macroeconomic episode may ultimately be characterized by a constant distribution of income. In this case, with τE = 0, we can rewrite the EPC in equation 7 as follows:
p=
1
(µα − µγU − (1 − µλ ) q E − µϕS E )
1−β
(7a)
It is clear from equations 7 and 7a that the episodic values of q and S influence the position of the EPC. We will return to this theme in section 2.4 (below).
2.3. Conditional Model Closure and Central Bank Behavior
The model as a whole is rendered conditionally closed by a convention—specifically,
the central bank’s target rate of inflation. This conditional closure can be stated as follows:
p = pT
T
where p denotes the central bank’s target rate of inflation. Having decided on this target
rate of inflation, the central bank is then assumed to set interest rates according to a reaction
function of the form:
r = r( p − p T ) −1 , r / > 0
(8)
In light of the relationship between unemployment and inflation discussed earlier, this
behavior imposes on the economy what Cornwall (1990) described as an inflation constraint. Any level of activity that creates inflation in excess of the central bank’s target will
provoke a subsequent rise in interest rates until activity has been depressed to a level at
which the inflation rate is once again consistent with the central bank’s target.
2.4. Summary and an Account of U.S. Macroeconomic Performance during the 1990s
As intimated earlier, the model developed above abstracts from two important themes
in heterodox macroeconomics—one Keynesian, the other Marxian—related to the distribu11. See Bowles and Boyer (1988, 1990) for an attempt to integrate these themes and to combine them with a
third—the social determination of work intensity and hence labor productivity. Note that by treating q as independent of U and S, the model above is also effectively abstracting from this third important theme in heterodox
macroeconomics.
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Figure 2.
Summary of Complete Model
tion of income.11 The Keynesian theme concerns the influence of income distribution on aggregate demand, as emphasized in neo-Kaleckian growth theory (see, e.g., Blecker 2002 for
a survey). According to this literature, τ ≠ 0 in equation 5 will influence the magnitude of D
associated with any given values of e* and r in equation 1, and in a way that depends on
whether the economy is stagnationist or exhilarationist. By treating the coefficients θ1, θ2,
and θ3 together with the state of long-run expectations as constants, equation 1 makes no allowance for this influence of income distribution on aggregate demand.
The Marxian theme from which the model above abstracts is the notion that the distribution of income is a function of the level of economic activity (as in the profit squeeze literature associated with Boddy and Crotty 1975) and/or the extent to which workers are collectively organized (as emphasized by Kalecki 1971). Hence, as described above, equation 5 is
consistent with variants of cost-plus pricing theory in which prices are determined as a
markup over unit labor costs, where the markup is, in turn, determined by firms’ degree of
monopoly power in product markets. Essentially, then, firms autonomously set τ (and hence
changes in the distribution of income), whereas variations in workers’ bargaining power
emanating from either changes in the level of economic activity or changes in institutions
affect only the rate of inflation (via their impact on the rate of growth of unit labor costs).12
In short, τ is independent of S and U in the model developed above, and, as such, the model
abstracts from the influence of workers’ bargaining power on the distribution of income as
described by Boddy and Crotty (1975) and Kalecki (1971).
12. Ultimately, this means that the model of aggregate wage and price setting (above) is consistent with a particular variant of conflicting claims inflation theory in which firms are able to fully index nominal wage growth
into inflation. See, for example, Lavoie (1992: 394–95).
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Together, these simplifications give rise to an easily decomposable macroeconomic
model in which the level of economic activity is determined by aggregate demand which is,
in turn, largely autonomous from the rest of the model (the exception being the lagged feedback effect operating via macroeconomic policy allowed in equation 8). Meanwhile, variations in workers’ bargaining power influence only the rate of inflation. The workings of this
model are summarized in Figure 2. The overall model achieves a state of conditional equilibrium when p = pT (as at p1) so that r³ = 0. Given the state of long-run expectations, the resulting conditional equilibrium rate of interest, r1, determines the level of aggregate demand
(D1) and hence the conditional equilibrium rate of unemployment, U1.
As can be seen from equations 7 and 7a, the episodic values of q and S are instrumental
in determining the position of the EPC in Figure 2. A great deal of attention has been paid to
the acceleration of productivity growth in the U.S. economy after 1995, a popular hypothesis being that this was related to the emergence of a “new economy” and represents a trend
increase in the rate of productivity growth (see, e.g., Oliner and Sichel 2000). Ironically, a
central feature of mainstream, NAIRU-based accounts of U.S. macroeconomic performance during the 1990s is that even a trend increase in the rate of productivity growth can
have no effect on the NAIRU but can at most shift the SRPC and permit a temporary
noninflationary reduction in unemployment lower than the NAIRU (Ball and Moffitt 2001).
According to the model developed above, however, if the 1990s did, indeed, witness the
emergence of a new “productivity regime” in the United States associated with an increase
in qE, this would shift the EPC in Figure 2 to the left, permitting a noninflationary reduction
in unemployment lower than U1 for the duration of a new episode in macroeconomic performance. Some authors are, however, skeptical about the extent to which there has been an increase in the trend rate of productivity growth in the United States (see, e.g., Gordon 2000),
and the question as to whether improved U.S. productivity growth during the late 1990s will
be sustained into the early twenty-first century remains open. From the perspective of the
model developed above, then, it is entirely possible that a temporary increase in q during the
1990s lowered the inflation costs associated with any given rate of unemployment in equation 6 without giving rise to the increase in qE necessary to facilitate a noninflationary reduction in unemployment during the course of a longer term episode of improved macroeconomic performance. In short, both the precise role of recent developments in productivity
growth in explaining the low unemployment and inflation rates experienced in the United
States during the 1990s, and the extent to which these recent developments have created
conditions conducive to a return to low rates of unemployment and inflation in the future,
remain ambiguous.
The focus here, however, is not on productivity growth but on another possible determinant of recent and future U.S. macroeconomic performance, namely, the idea that during the
past three decades, there have been lasting structural changes in the U.S. labor market that,
by the 1990s, created a new, higher value of SE.13 These structural changes are largely associated with changes in the institutional framework that defines the “operating system” or
“rules of the game” in the labor market, in the context of which workers and firms interact.
They are reflected in phenomena such as increases in corporate relocations, downsizing ex13. The reader is again reminded that S and q are treated as independent variables here. No attempt is made to
account for the possible relationship between them that may arise from the social determination of work intensity at the point of production.
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Figure 3.
An Account of U.S. Macro Performance during the 1990s
ercises, declining rates of unionization, changes in labor law, and increases in the quantity
of “nonstandard” (i.e., part-time and contingent) employment—all of which have been unfavorable to labor (Block, Beck, and Kruger 1996; Osterman 1999; Peck 2001; Setterfield
2003b). Having emerged initially during the 1970s as part of a state- and corporate-led response to the end of the postwar Golden Age of macroeconomic performance, by the 1990s,
these changes had become entrenched and consolidated to the extent that it is possible to
postulate that they now form a new and durable institutional architecture of the U.S. labor
market (Houston 1992; Lippit 1997, 2003; Peck 2001). Their impact on U.S. macroeconomic performance is illustrated in Figure 3. Here, an increase in the value of SE creates a
new EPC during the 1990s that lies beneath the old EPC. As such, the unemployment rate
U1 is now associated with inflation rate p2 < pT, as a result of which r³ < 0 in equation 8. As r
declines, the level of aggregate demand increases and the unemployment rate falls (assuming a constant state of long-run expectations) until inflation returns to p1 = pT. At this point,
overall conditional equilibrium is regained but with lower interest rates and lower unemployment. Significantly, there has been no increase in the conditional equilibrium rate of inflation. These outcomes correspond broadly to those observed in the U.S. economy during
the 1990s. The hypothesis here, then, suggests that improved U.S. performance during the
1990s resulted from a combination of expansionary monetary policy in the context of a demand-constrained economy and “favorable” supply-side developments associated with the
consolidation of structural changes in the U.S. labor market that alleviated the inflation constraint on U.S. macroeconomic policy and performance.14
14. The supply-side developments described here were, of course, only favorable in the sense that they alleviated the inflation constraint. As noted earlier, they were in and of themselves distinctly unfavorable to workers in
the sense that they caused a diminution of the relative power of workers in the wage bargain.
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3. Structural Change and Macroeconomic
Outcomes: An Empirical Investigation
In this section, we test the hypothesis developed above that structural changes in the
U.S. labor market have alleviated the inflation constraint on U.S. macroeconomic policy
and performance, establishing the supply-side foundations for the beginnings of a new episode of improved macroeconomic performance in the United States during the 1990s. To do
this, we focus on estimating a Phillips curve of the form in equation 6. Annual data for the
U.S. economy from 1973 to 2000 are used for the purposes of this estimation process, because the discrete episode of macroeconomic performance that we are trying to model here
arose only after the decline of the Golden Age and its radically different labor market institutions (on which see, e.g., Cornwall 1990; Bowles, Gordon, and Weisskopf 1990).15 The
variables used in the regressions are defined in Table 1, wherein data sources are also
identified.
Our first task is to identify a basic empirical specification of the SRPC into which variables proxying S can then be introduced to test the hypothesis that increases in worker insecurity independent of changes in the unemployment rate help explain recent U.S. macroeconomic outcomes. Table 2 reports the results of this specification search. Equation E1 is
consistent with a version of equation 6 in which S is ignored, τ = 0 (i.e., the wage share of income is assumed constant), and λ = 0 (i.e., aspirations have no impact on target real wage
growth in equation 3). Equation E2, meanwhile, modifies this view by setting λ = µ = 1(as pirations are entirely objective, and target real wage growth is fully indexed into actual
nominal wage growth), so that p varies with −(1 − δ )(q − a ) in equation 6 (as in Ball and
Moffitt 2001), and by allowing for changes in the gross markup (τ ≠ 0). As can be seen from
Table 2, both ASPGAP (which measures [q – a]) and MARKUPGROWTH are of the expected sign and are statistically significant (the latter at the 10 percent level), and equation
E2 offers a modest increase in explanatory power relative to E1. Equation E3 postulates that
λ , µ ≠ 1, so that q and a must be entered separately as regressors in the SRPC. E3 reveals that
the variables PRODUCTIVITYGROWTH and RWGASP (which measures a) are both statistically significant, and an F test on equations E2 and E3 reveals that we cannot reject the
null hypothesis that βRWGASP = –βPRODUCTIVITYGROWTH.16 This corroborates the interpretation of the
U.S. Phillips curve forwarded by Ball and Moffitt (2001), according to which the lagged response of real wage growth aspirations to changes in productivity growth contributes to the
explanation of U.S. inflation during the past thirty years. Finally, equation E4 expands on
E2 by including an estimate of the rate of growth of the value of employee stock options as a
regressor. The hypothesis here is that by changing the way that employees are compensated,
15. Data from 1968 to 2000 are used in some of the preliminary regressions reported below. According to
some authors, the decline of the Golden Age in the United States dates back to 1968 (Bowles, Gordon, and
Weisskopf 1990). Our main hypothesis is, however, tested using post-1973 data, because there is general agreement that the government and corporate response to the decline of the Golden Age with which we are associating
structural change in the U.S. labor market did not begin until the 1970s.
16. F = 0.33 < 4.2 = Fcritical.
17. The quality of the STOCKOPVALGROWTH data is admittedly poor, because it is very difficult to estimate the number of U.S. employees who received stock options prior to the early 1990s. I am grateful to Corey
Rosen of the National Center for Employee Ownership for help with compiling these data.
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Setterfield / U.S. Macroeconomic Performance in the 1990s
167
Table 1
Definitions of Regression Variables and Identification of Data Sources
ASPGAP
PRODUCTIVITY GROWTH−RWGASP
CUMEMPGROWTHDIF
The cumulative value of the difference between the annual rates of growth of
manufacturing employment in the South and West (the South Atlantic, East
South Central, West South Central, Mountain, and Pacific census divisions)
and the rust belt (the East North Central and Middle Atlantic census divisions) (Bureau of Labor Statistics [BLS])
EXCHGROWTH
Differences in logs of the real, trade weighted exchange rate (broad index;
Board of Governors of the Federal Reserve)
INDEX
Index of worker insecurity calculated as (PARTTIME +
T
T
T
T
CUMEMPGROWTHDIF + UNION + WSTOPNUM + OPENNESS )/5,
where, based on United Nations (2000: 269):
T
x itT =
x it − x i min
x i max − x i min
for i = PARTTIME, CUMEMPGROWTHDIF, OPENNESS; and
x itT =
x i max − x it
x i max − x i min
for i = UNION, WSTOPNUM
INFLATION
Differences in logs of CPI-U, all items (BLS)
INFLATIONEXPECS
INFLATION lagged one period
INFLATIONGDP
Differences in logs of the GDP deflator (Bureau of Economic Analysis [BEA])
INFLATIONEXPECSGDP
INFLATIONGDP lagged one period
MARKUPGROWTH
Difference between the rate of growth of output per hour of all persons in the
business sector and the rate of growth of real compensation per hour in the
business sector (BLS)
NIXON
Dummy variable for the Nixon price controls (0.5 in 1972 and 1973, 0.3 in
1974, and 0.7 in 1975)
OPENNESS
Real exports plus real imports divided by real GDP (BEA)
PARTTIME
The percentage of all employed persons who are usually employed part-time
(Current Population Survey [CPS], BLS)
PRODUCTIVITYGROWTH
Rate of growth of output per hour of all persons in the business sector (BLS)
RELCOMMODGROWTH
Differences in logs of the KR-CRB spot commodity price index, all commodities (Commodity Research Bureau) minus INFLATION
RELENERGYINF
Differences in logs of the CPI for energy (BLS) minus INFLATION
RELENERGYINFGDP
Differences in logs of the CPI for energy (BLS) minus INFLATIONGDP
RWGASP
Koyck lag of the rate of growth of real compensation per hour in the business
sector (β = 0.95). The initial value of RWGASP used in the calculation of this
series is the trend rate of growth of real compensation per hour in the business
sector in 1959, this trend rate of growth having been derived from a
Hodrick-Prescott filter.
STOCKOPVALGROWTH
Rate of growth of the NASDAQ composite index multiplied by the percentage
of all employees who hold stock options (New York Stock Exchange, National Center for Employee Ownership)
UNEMPLOYMENT
Unemployment rate of all civilian workers (BLS)
(continued)
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Review of Radical Political Economics / Spring 2005
Table 1 (continued)
UNION
The percentage of employed workers who are members of a labor union or an
association similar to a union (CPS, BLS)
WSTOPNUM
Total number of work stoppages beginning in each year (BLS)
Table 2
Searching for a Basic Empirical Specification of the SRPC (Sample 1968-2000)
E1
E2
CONSTANT
5.260
(5.214)
3.909
(4.407)
INFLATIONEXPECS
0.933
(8.751)
0.821
(8.051)
PRODUCTIVITYGROWTH −0.580 (−3.545)
UNEMPLOYMENT
E3
3.303
(2.392)
5.199
(3.714)
0.791
(6.880)
0.866
(8.124)
−0.790 (−4.554)
−0.620 (−3.253) −0.570 (−3.180) −0.533 (−2.779) −0.782 (−3.322)
ASPGAP
−0.812 (−4.857)
−0.829 (−4.150)
STOCKOPVALGROWTH
−11.888 (−0.249)
RWGASP
MARKUPGROWTH
R
2
Adjusted R
Durbin h
2
E4
0.390
(1.926)
1.036
(2.455)
0.381
(1.858)
0.847
0.383
0.799
0.845
0.778
0.823
0.818
0.841
1.959
2.117
2.405
1.385
(1.763)
0.869
Note: All regressions are OLS in which the dependent variable is INFLATION. Figures in parentheses are t
statistics.
stock options may have diminished pressure on nominal wage growth and hence inflation
(Baker 2000: 226–27; Mehron and Tracy 2001). The stock option variable is, however, statistically insignificant and is dropped from subsequent regressions.17
18. The precise choice of proxies evident in Table 3 is pragmatic, motivated to a substantial extent by the
availability of data. The proxies used are by no means exhaustive—other potential candidates might include a
measure of the intensity of work supervision or the proportion of families with multiple income earners (the hypothesis being that dependence on multiple sources of income reduces the geographical mobility and hence the
outside option of any individual working family member, and consequently their ability to contest employment
conditions in their current job). It remains for future studies to explore these and other potential proxies for S.
19. This measure of capital mobility is based on Crandalls (1993) observation that differences in the rates of
growth of manufacturing employment as between the rust belt and the U.S. South and West are primarily explained by the willingness of manufacturers to relocate employment in response to regional differences in economic variables such as wage rates and rates of unionization. At the same time, this willingness to relocate is evident mainly since the early 1970s, despite the fact that the regional differences in wage and unionization rates
that explain it predate the 1970s. This suggests that corporate relocation within the United States proxies a
change in employment relation conventions dating from the early 1970s rather than a continuous response to regional unit labor cost differentials. As is evident from the structure of the CUMEMPGROWTHDIF variable, the
hypothesis entertained here is that it is the cumulative legacy of corporate relocation behavior (rather than its
current rate) that affects the credibility of firms’ threats to relocate production, and hence the insecurity of
workers.
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169
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0.423
−1.105 (−4.111)
MARKUPGROWTH
PARTTIME
2
2
0.912
0.569
(2.665)
1.814
(1.522)
(7.151)
0.744
0.908
0.925
0.238
0.328
(3.887)
(2.014)
−0.794 (−4.967)
−0.644 (−4.493)
0.681
E6
4.257
(4.678)
(7.698)
1.113
0.898
0.917
0.007
0.341
(3.409)
(1.994)
−0.648 (−3.769)
−0.649 (−4.283)
0.732
E7
8.196
(6.569)
(7.668)
(2.007)
0.921
0.898
0.917
−0.525 (−3.427)
0.342
−0.740 (−4.411)
−0.706 (−4.837)
0.730
E8
(8.618)
(5.113)
E9
(1.584)
0.963
0.888
0.909
−18.002 (−2.938)
0.288
−1.068 (−5.285)
−0.594 (−3.505)
0.803
10.603
Note: All regressions are OLS in which the dependent variable is INFLATION. Figures in parentheses are t statistics.
Durbin h
Adjusted R
R
INDEX
OPENNESS
CUMEMPGROWTHDIF
WSTOPNUM
0.928
−0.440 (−2.502)
UNEMPLOYMENT
UNION
−0.760 (−5.732)
ASPGAP
(5.207)
0.701
INFLATIONEXPECS
(7.794)
22.931
CONSTANT
E5
Table 3
The Impact of Labor Market Institutions on the U.S. Phillips Curve (Sample 1973-2000)
(7.786)
(7.333)
(2.080)
0.748
0.909
0.926
−3.491 (−3.964)
0.338
−0.741 (−4.670)
−0.644 (−4.538)
0.708
7.809
E10
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Review of Radical Political Economics / Spring 2005
Table 3 reports estimates of SRPCs that modify E2 by introducing various different
variables designed to measure the impact of the institutional structure of the U.S. labor market on the relative bargaining power of workers in the wage determination process. The
problem that we are confronted with here, of course, is that the variable S in equation 6 is
unobservable. We are therefore forced to find proxies for this variable, and the regressions
reported in Table 3 include several such proxy variables.18 PARTTIME measures the growth
of nonstandard employment since the 1970s, the hypothesis being that the growth of
nonstandard employment reduces the security and hence the relative bargaining power of
employees who wish to remain in full-time, year-round jobs. UNION and WSTOPNUM
measure the ability and willingness of workers to engage in industrial action in support of
wage claims—things that are partly a reflection of changes in labor law and the changes in
corporate and government attitudes toward the function of trade unions that lie behind these
legal changes (Block, Beck, and Kruger 1996). The relative bargaining power of workers
will vary directly with these variables. CUMEMPGROWTHDIF proxies the willingness of
corporations to relocate production facilities within the United States.19 The threat of job
loss that a credible threat to relocate imposes on workers suggests that the latter’s relative
bargaining power will vary inversely with the extent to which capital is mobile. Of course,
the mobility of productive capital has more recently developed an important international
dimension. U.S. workers are frequently threatened with the relocation of production facilities abroad, especially when in the process of collective organization (Bronfenbrenner
2000). Hence, the variable OPENNESS is designed to capture both the exposure of U.S.
workers to foreign competition—including that emanating from countries with lower employment standards than the United States—and the opportunity that international trade
now presents for U.S. capital to relocate production abroad and export their final output
back to the United States. Workers’ relative bargaining power will therefore vary inversely
with this variable.
The variables described above are introduced into the basic SRPC specification in equation E2 in a piecewise fashion because of the considerable collinearity among them. This
collinearity is hardly surprising given that the variables in question are all proxying the
same thing, namely, institutional change in the labor market characterized by the end of the
“social bargain” approach to labor relations that characterized the Golden Age and the onset
of a “market power” approach in which firms (backed by the state) have attempted to subordinate labor. It is also likely that some of the variables are causally linked. For example,
WSTOPNUM is surely a function of UNION, and evidence suggests that the latter is, in turn,
influenced by the threat of capital mobility proxied by the CUMEMPGROWTHDIF variables (Bronfenbrenner 2000). As such, the various proxies for S described above are interpreted as substitutes for, rather than complements to, one another in the regressions reported
in Table 3. This also explains the purpose of the variable INDEX in Table 3. INDEX is a
composite measure of worker insecurity based on all five of the proxy variables described
earlier and constructed in such a way that an increase in INDEX can be associated with a
diminution of workers’ relative bargaining power. Note that the empirical evidence presented here does not demonstrate that INDEX is necessarily a better proxy measure of
worker insecurity than any of its individual constituent parts. But INDEX does, at least, have
20. A direct measure of this importance can be found in Table 6, which demonstrates the capacity of an EPC
based on equation 7a and the results in Table 3 to explain observed U.S. inflation outcomes during the 1990s.
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Setterfield / U.S. Macroeconomic Performance in the 1990s
171
the virtue of combining the informational content of the other proxy variables—a useful
feature given that these variables cannot be separately entered into the same regression by
virtue of their collinearity.
Two interesting conclusions emerge from Table 3. First, regardless of the variable that
we use to proxy the institutional structure of the U.S. labor market, this variable is always of
the correct sign and statistically significant. Second, each of the equations reported in Table
3 offers a marked increase in explanatory power relative to equation E2 (the preferred equation from our initial specification search). Note also that, comparing the estimated coefficients for INFLATIONEXPECS in Table 3 with its estimated coefficient in equation E2, it
would seem that some part of what authors such as Gordon (1998) identified as the considerable inertia in the inflation process is, in fact, explained by the sort of variables used here
to capture the institutional structure of the labor market. On the basis of these results, we can
conclude that institutional features of the U.S. labor market make an important contribution
to the explanation of inflation outcomes in the United States since 1973. 20
Table 4 reports the results of various tests of the robustness of the results in Table 3.21
Equation E11 replaces MARKUPGROWTH with three variables designed to capture the impact of specific types of supply shocks that affect inflation independently of the growth of
unit labor costs. These include the rate of growth of relative commodity prices
(RELCOMMODGROWTH), the rate of growth of the real exchange rate (EXCHGROWTH),
and a dummy variable designed to capture the effects of the Nixon price controls. As can be
seen from E11, none of these variables has a statistically significant effect on inflation.
When, however, RELCOMMODGROWTH is replaced with a measure of the rate of growth
of relative energy prices (RELENERGYINF) in equation E12, this latter variable proves to
be statistically significant. This finding—together with the continued statistical significance of the ASPGAP variable—lends credence to the claim that temporary supply shocks
have contributed to observed U.S. inflation rates since 1973. More important for the purposes of this article, however, is the observation that INDEX remains statistically significant
in E11 and E12. Changing the specification of supply shock variables, then, does not affect
our earlier conclusion that INDEX makes a statistically significant contribution to the
explanation of U.S. inflation since 1973.
In equations E13 and E14, inflation is measured using the GDP deflator rather than the
consumer price index (CPI). This change in the data used to measure the rate of inflation
renders NIXON statistically significant at the 5 percent level and reduces the rate of growth
of relative energy prices (now measured as RELENERGYINFGDP) to significance at the 10
percent level. It makes no difference to our conclusions, however, regarding the statistical
significance of INDEX. Finally, equations E15 and E16 change the structure of the lags in
equations E10 and E12 respectively. E15 and E16 provide no evidence that the lags in E10
and E12 are misspecified. More importantly, INDEX remains statistically significant in both
equations.
21. For the purposes of this exercise, equation E10 is treated as the preferred empirical specification of equation 6. E10 is preferred because, as remarked earlier, the INDEX variable combines the informational content of
each of the five other variables used to proxy S. As such, it would appear to be a priori the most satisfactory of the
various proxies for S used in the regressions in Table 3.
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172
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0.682
INFLATIONEXPECS
(5.898)
(4.723)
0.940
2
0.804
0.896
0.923
0.541
0.932
0.949
0.926
−0.925
−1.510
0.936
0.953
−1.693 (−2.255)
(0.690)
0.929
0.012
(0.479)
(0.161)
−4.076 (−2.663)
−0.704 (−3.140)
−0.526 (−3.187)
(3.237)
(4.727)
0.909
0.924
N/A
0.882
0.914
Note: All regressions are OLS, and figures in parentheses are t statistics. The dependent variable in equations E11, E12, E15, and E16 is INFLATION, and in equations
E13 and E14, it is INFLATIONGDP.
Durbin h
Adjusted R
2
−0.258 (−0.274)
2.130
(1.776)
(1.776)
−3.631 (−4.072)
0.295
−0.604 (−2.877)
−0.612 (−4.209)
−0.129 (−1.001)
0.645
8.505
−0.624 (−0.323)
R
−1.080 (−0.822)
−0.056 (−0.015)
0.046
(6.555)
(7.155)
E16
NIXON
(1.107)
(3.379)
−3.390 (−3.384)
−0.220 (−1.434)
7.424
0.765
E15
2.199
4.715
0.120
(4.468)
(4.620)
−0.239 (−2.512)
0.568
5.030
E14
EXCHGROWTH(1)
EXCHGROWTH
RELENERGYINF(1)
RELENERGYINFGDP
(0.743)
0.021
RELENERGYINF
RELCOMMODGROWTH
(2.524)
0.311
−2.470 (−2.970)
INDEX
−3.104 (−3.163)
−3.734 (−2.479)
MARKUPGROWTH
−0.462 (−3.295)
−0.431 (−4.046)
−0.673 (−3.983)
−0.350 (−2.103)
−0.487 (−3.365)
(6.940)
(5.962)
UNEMPLOYMENT
4.929
ASPGAP
−0.400 (−3.454)
0.560
6.079
E13
0.782
(4.466)
(4.955)
E12
INFLATIONEXPECSGDP
INFLATIONEXPECS(1)
7.963
CONSTANT
E11
Table 4
How Robust Is the Impact of Labor Market Institutions on the U.S. Phillips Curve? (Sample 1973-2000)
Setterfield / U.S. Macroeconomic Performance in the 1990s
173
Table 5
Predicted Rates of Inflation Associated with a 4.5 Percent Unemployment Rate 1973-1989 and 1990-2000
Period
Predicted Rate of Inflation (%)
1973-1989
a
10.43
1990-2000
b
5.55
a. Calculated as p =
1
1 − β p
(CONSTANT + β U * 4.5 + β S SE ) where SE is the average annual value of INDEX
1973-1989, and regression coefficients are derived from equation E10.
1
(CONSTANT + β U * 4.5 + β S SE ), where SE is the average annual value of INDEX
b. Calculated as p =
1 − β p
1990-2000, and regression coefficients are derived from equation E10.
Table 6
Predicted and Actual Rates of Inflation Associated with a 5.6 Percent Unemployment Rate 1990-2000
Proxy Measure of S
INDEX
a. Calculated as p =
Predicted Rate of
a
Inflation 1990-2000 (%)
Actual Annual Average
Rate of Inflation 1990-2000
2.75
2.99
1
(CONSTANT + β U * 5.6 + β S SE ), where SE is the average annual value of INDEX
1 − β p
1990-2000, and regression coefficients are derived from equation E10.
In sum, the results in Table 4 suggest that our finding that labor market institutions designed to create worker insecurity have had a statistically significant impact on U.S. inflation since 1973 is empirically robust.
It remains to be shown that it is empirically plausible to argue that, by the 1990s, institutional change in the U.S. labor market had created a new EPC capable of permitting the improved macroeconomic performance (lower unemployment without any increase in inflation) described in Figure 3. This is demonstrated in Table 5, which reports the rates of
inflation associated with a 4.5 percent rate of unemployment for 1973-1989 and 1990-2000
as calculated from equation 7a, in which we set λ = µ = 1 in keeping with our earlier results
that there is no statistically significant difference between equations E2 and E3, SE is set
equal to the average annual value of INDEX for 1973-1989 and 1990-2000, and coefficients
are taken from the regression results for equation E10 as reported in Table 3. As is clear
from Table 5, the Phillips curve estimated in equation E10 suggests that the inflation cost of
a 4.5 percent rate of unemployment in the United States during the 1990s was about half of
that during the period 1973-1989. To the extent that the average annual value of INDEX between 1990 and 2000 can be interpreted as a durable, episodic value of this variable, this
suggests that the U.S. EPC did indeed shift to the left during the 1990s because of the consolidation of institutional changes in the U.S. labor market that began in the 1970s, as postulated in Figure 3. This result modifies the conclusions of Setterfield and LeBlond (2003),
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Review of Radical Political Economics / Spring 2005
according to whom there is no evidence of a shift in the U.S. Phillips curve during the
1990s. It also resolves the so-called paradox for heterodox economists posed by Setterfield
(2003b: 77), according to which “evidence of structural change in U.S. labor markets is everywhere, except in Phillips curve regressions.”
We can also use equation 7a and the regression results in Table 3 to predict the average
annual rate of inflation associated with a 5.6 percent rate of unemployment (this being the
actual annual average rate of unemployment in the United States between 1990 and 2000).
The results of this exercise are reported in Table 6. The predicted annual average rate of inflation reported in Table 6 (2.75 percent) compares to an actual average annual rate of inflation in the United States between 1990 and 2000 of 2.99 percent. This suggests that an EPC
of the form described in equation 7a with coefficients taken from the regression results reported in Table 3 does a good job of predicting the actual rate of inflation in the United
States during the 1990s.
4. Conclusions and Prognosis
This article has developed a model of short-run macroeconomic outcomes in which the
economy is demand constrained, money is nonneutral, and institutions play a vital role in
creating conditional closure in the otherwise open processes determining macroeconomic
outcomes. In particular, institutions structure the socioeconomic process based on bargaining and the exercise of power, through which value and distribution are determined as a result of the conflicting nominal income claims of workers and firms. These same processes
are associated with inflation and hence the “inflation constraint” on macroeconomic performance (Cornwall 1990), which comes into effect when policy makers are unwilling to tolerate inflation higher than a certain target level. The model has been used to explain recent
U.S. macroeconomic performance by hypothesizing that institutional changes in the U.S.
labor market play an important role in explaining inflation outcomes in the U.S. economy
after 1973. It is hypothesized that, by the 1990s, these institutional changes had consolidated into a new and relatively enduring institutional framework in the U.S. labor market,
creating a new form of conditional closure in the wage- and price-setting processes.22 This,
it is argued, has created supply-side conditions consistent with a relaxation of the inflation
constraint and favorable to the onset of a new episode of macroeconomic performance during which low unemployment can be achieved without triggering increases in inflation—as
during the late 1990s. Both regression results based on U.S. data from 1973 to 2000, and
subsequent comparisons of the inflation costs of a given rate of unemployment during the
period 1990-2000 with (1) the inflation cost of the same rate of unemployment during
1973-1989 and (2) the actual rate of inflation in the United States during 1990-2000, are
consistent with this account of recent U.S. macroeconomic performance.
There exists an important contrast between the account of recent U.S. performance associated with the discussion of favorable supply shocks in mainstream, NAIRU-based mac22. This hypothesis (and the empirical evidence that supports it) is compatible with the claims of other authors who argue that labor market institutions rather than autonomous technological developments are of crucial
importance in understanding other recent macroeconomic developments, such as the increasing dispersion of
relative wages and the growth of income inequality (see, e.g., Galbraith 1998; Howell 1999).
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Setterfield / U.S. Macroeconomic Performance in the 1990s
175
roeconomics and the account developed above. According to the mainstream view, the
United States can only achieve low unemployment and low inflation (as during the 1990s)
temporarily: ultimately, a choice between sacrificing low unemployment or stable inflation
awaits U.S. policy makers. There is, however, no reason to believe that there is anything
transitory about the institutional changes in the U.S. labor market that are central to the
account of recent U.S. performance developed here. Instead, much of the new architecture
of the U.S. labor market appears to constitute precisely the sort of relatively enduring institutional framework capable of supporting a prolonged episode of macroeconomic performance that will extend beyond a single trade-cycle boom. This interpretation is admittedly
conjectural—the evidence presented in the previous section does not unambiguously demonstrate that institutional changes in the U.S. labor market have shifted the EPC rather than
just the SRPC. But if it is correct, the prognosis must be that the supply side of the U.S.
economy is primed to facilitate a return during the course of the next decade to the low unemployment and low inflation outcomes characteristic of the 1990s. According to this view,
the challenge for U.S. policy makers is not to choose between low unemployment and stable
inflation but to maintain aggregate demand at levels capable of sustaining the low unemployment rates witnessed during the late 1990s. This, in itself, may well prove problematic.
For example, as noted earlier, the model in section 2 abstracts from the influence of labor
market institutions on the distribution of income and from the influence of income distribution on aggregate demand. If the U.S. economy is stagnationist, the very changes that we are
postulating as having shifted the U.S. EPC may, at the same time, be undermining aggregate
demand. Alternatively, even in the absence of stagnationist tendencies, the growth of aggregate demand in the United States may be unsustainable as a result of financial fragility associated with the distribution of debt among the public, household, and corporate sectors of
the economy (Godley and Izurieta 2001). There is also the possibility that the inflation constraint on macroeconomic activity will reassert itself, despite the institutional changes in the
U.S. labor market emphasized above. This might occur if, for example, a combination of
chronic trade deficits and an unwillingness of foreign savers to lend to the United States
causes a depreciation of the U.S. dollar and an increase in imported inflation. The resulting
situation would then create the worst of all worlds for U.S. workers—rising unemployment
designed to combat imported inflation in addition to the reduced employment security that
characterizes the contemporary labor market. Having said this, the possibility remains that
the macroeconomic performance of the 1990s is sustainable, based on a combination of two
factors: the maintenance of buoyant aggregate demand conditions; and a relaxation of the
inflation constraint on macroeconomic performance resulting from an “incomes policy
based on fear,” in which fear is generated by relatively enduring institutional features of the
labor market that have increased worker insecurity rather than by labor market outcomes
such as unemployment.
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Mark Setterfield is associate professor of economics at Trinity College, Hartford, Connecticut. His main research interests are macrodynamics (with a particular focus on concepts of path dependence) and post-Keynesian economics. He is the author of Rapid Growth and Relative Decline: Modelling Macroeconomics Dynamics
with Hysteresis (Macmillan, 1997); is the editor of Growth, Employment and Inflation: Essays in Honour of
John Cornwall (Macmillan, 1999), and Demand-Led Growth: Challenging the Supply Side Vision of the Long
Run (Edward Elgar, 2002); and has published in numerous journals including the Cambridge Journal of Economics, Journal of Post Keynesian Economics, European Economic Review, Review of Political Economy,
Journal of Economic Issues, and The Manchester School.
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