Academic journal article Economic Inquiry

Labor Supply Constraints, Profit-Sharing and Volatility Rents in an Unstable Economy

Academic journal article Economic Inquiry

Labor Supply Constraints, Profit-Sharing and Volatility Rents in an Unstable Economy

Article excerpt

I. INTRODUCTION

Since the end of the 1930s, the portion of U.S. national income claimed by wages and salaries has been in the low sixty percents, fluctuating between a low of 60.3 percent in 1942 and a high of 66.2 percent in 1970. The average has been slightly below 63 percent over this interval. Obviously we cannot know what the share distribution would have been had the economy traversed a perfectly smooth equilibrium growth path. But does the observed long-term average provide an unbiased estimate of long-run equilibrium? The question arises in the context of recent suggestions by Martin Weitzman |1984^ and James Meade |1986^ and others that a move away from fixed-wage contracting would reduce cyclical unemployment.

An oft-cited consequence of the convexity of profits in output prices is that in the absence of adjustment costs, price stabilization will reduce the long-term average profits of firms.(1) This is possible because the residual claimant retains the option of adjusting the level of operations in response to business conditions. It is therefore interesting that profit-sharing for the sake of macroeconomic stability has sometimes been recommended as distributionally neutral, or "isomorphic," in its long-run equilibrium properties.(2) Since profit-sharing dilutes profit's claim on the residual share by giving labor a part, we ask in this paper whether firm owners must thus give up the aforementioned "rents to volatility."

The Euler-Walras concept of a general equilibrium applies to an imaginary steady state of the economy in which all prices have settled down to their market-clearing levels.(3) Marginal productivities determine the functional distribution of a constant overall income. But, in fact, it is only appropriate to use the Euler-Walras shares as the focal point around which cyclical forces influence the income shares if every characteristic of an economy in recession is symmetrically reversed under boom conditions. Full symmetry would require that firms be free to increase employment in good times to the same extent that they can reduce their employment levels in slack times. This marks a very important distinction between the micro-economics of fully competitive input markets and the macroeconomics of the business cycle. If a cleared labor market is part of the definition of the Walrasian equilibrium, then any increase in boom-state hiring must be limited by the elasticity of the overall labor supply. In the aggregate, this elasticity must be far from infinite. This will be true whether we view workers as utility maximizers balancing income against leisure, or as being forced at a corner solution to simply choose between employment and unemployment. There is no equivalent limit (short of the whole labor force) to the number of workers who can be cut loose by the firm in a recession.

We construct here a very simple partial equilibrium model of a representative Cobb-Douglas firm, which is macroeconomic in the sense that labor-constrained booms are assumed to alternate with recessions. The firm is free to hire the optimal amount of labor within its labor-supply constraint, but is not free to alter labor contracts over the business cycle. Contracts are consistent with a cleared labor market only in the long-run steady state.(4) In the boom state of the economy, the firm under fixed wages is able to obtain the full benefit of the gap which develops between the revenue product of labor and the wage. If, on the down side of the cycle, unemployment is avoided by the use of profit-sharing contracts, the firm must sacrifice part of these benefits, and more than 100 percent of the gains from the saved output may go to labor's share. To the extent that these arguments apply in vivo (their analytical validity can be demonstrated for a wide range of models), more doubt is cast upon the distributional neutrality of profit-sharing contracts. But we might also question the basic nature of the fixed-wage system. …

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