BANK OF FINLAND DISCUSSION PAPERS

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1 BANK OF FINLAND DISCUSSION PAPERS Berthold Herrendorf Arilton Teixeira Research Department Monopoly rights can reduce income big time Suomen Pankin keskustelualoitteita Finlands Banks diskussionsunderlag

2 Suomen Pankki Bank of Finland P.O.Box 160 FIN HELSINKI Finland

3 BANK OF FINLAND DISCUSSION PAPERS Berthold Herrendorf* Arilton Teixeira** Research Department Monopoly rights can reduce income big time The views expressed are those of the authors and do not necessarily reflect the views of the Bank of Finland. We are grateful to Edward Prescott and James Schmitz for their advice and encouragement, to Peter Klenow for helping us with the price data, and to Ákos Valentinyi for pointing out several errors in an earlier version. We have profited from suggestions by Michele Boldrin, Ricardo Cavalcanti, Marco Celentani, Juan Carlos Conesa, Antonia Díaz, Ron Edwards, Fernando Garcia-Belenguer, Thomas Holmes, José Victor Ríos-Rull, Juan Ruiz, Michele Tertilt, and the audiences of presentations at Arizona State University, Bank of Finland, Carlos III, Edinburgh, the European Forum in Maastricht, Foundation Gestulio Vargas (Rio de Janeiro), Ibmec, the Madrid Macro Seminar (MadMac), Oslo, the SED Meetings in Paris, Southampton, the Thanksgiving Conference in Essex, UCLA, the University of Barcelona, the Vigo-Workshop in Dynamic Macroeconomics, and Warwick. Herrendorf acknowledges research funding from the Spanish Dirección General de Investigación (Grant BEC ) and from the Instituto Flores Lemus (Universidad Carlos III). * Universidad Carlos III de Madrid, Departamento de Economía, Calle Madrid, 126, Getafe (Madrid), Spain; University of Southampton; CEPR. herrendo@eco.uc3m.es. ** Ibmec, Department of Economics, Av. Rio Branco, 108/12o. andar, Rio de Janeiro, RJ, , Brazil. arilton@ibmecrj.br. Suomen Pankin keskustelualoitteita Finlands Banks diskussionsunderlag

4 ISBN ISSN (print) ISBN ISSN (online) Multiprint Oy Helsinki 2004

5 Monopoly rights can reduce income big time Bank of Finland Discussion Papers 7/2004 Berthold Herrendorf Arilton Teixeira Research Department Abstract We ask which part of the observed cross-country differences in the level of per capita income can be accounted for by monopoly rights in the labour market. We answer this question in a calibrated growth model with two final goods sectors. The novel feature being that monopoly rights in the capital-producing sector shield insiders from competition by outsiders and permit coalitions of insiders to choose inefficient technologies or working practices. We find that monopoly rights can lead to quantitatively much larger reductions in the level of per capita income than previously demonstrated. This comes about because they do not only reduce TFP in capital-producing sector but also increase the relative price of capital. This reduces the capital-labour ratio in the whole economy. The implied predictions about the price of capital goods relative to consumption goods and the investment share in output are quantitatively consistent with the cross-country facts. Key words: cross-country income differences, cross-country productivity differences, monopoly rights, relative price of capital, capital accumulation. JEL classification numbers: EO0, EO4 3

6 Monopolivoima voi vähentää tuloja rajusti Suomen Pankin keskustelualoitteita 7/2004 Berthold Herrendorf Arilton Teixeira Tutkimusosasto Tiivistelmä Tässä työssä tarkastellaan kysymystä, missä määrin henkeä kohti lasketun tulotason erojen eri maiden välillä voidaan selittää johtuvan työmarkkinoiden monopolisoitumisesta. Kysymykseen vastataan kalibroidulla kasvumallilla, jossa talous on jaettu kahteen lopputuotteita tuottavaan sektoriin. Uusi piirre mallissa on, että monopolivoima pääomatavaroita tuottavalla sektorilla suojaa sisäpiiriä ulkopuoliselta kilpailulta ja antaa sille mahdollisuuden käyttää tehotonta tekniikkaa tai tehottomia työtapoja. Tulokset osoittavat, että monopolivoima työmarkkinoilla voi johtaa paljon suurempaan tulotason laskuun kuin aiemmin on pystytty osoittamaan. Tulos johtuu siitä, että monopolivoima ei ainoastaan heikennä tuottavuutta pääomatavaroita tuottavalla sektorilla vaan myös nostaa pääoman suhteellista hintaa. Pääoman kallistuminen supistaa pääoma-työsuhdetta koko taloudessa. Kansainvälisessä aineistossa pääoma- ja kulutustavaroiden hintasuhde ja talouden investointiaste käyttäytyvät mallin ennustamalla tavalla. Avainsanat: kansainväliset tuloerot, kansainväliset tuottavuuserot, monopolivoima, pääoman suhteellinen hinta, pääomanmuodostus JEL-luokittelu: EO0, EO4 4

7 Contents Abstract...3 Tiivistelmä Introduction Model economy Environment Equilibrium Analytical results Quantitative results Discussion Conclusions...26 References...28 Appendix A Derivations and proofs of the propositions

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14 g J n n W f n f W ] 2 7 ' 7 J n ' J n ] 2 ] 2 7 _c +518d, _c ' g J n neb g J n g _ ' g r n 'u rj n neb g _c ] 2 ] 2 g 5 _c u 5 J _c ] 2 g n +518e, +518f, +518g, +518h, 'u r n u 5 c 5 dc 2o +518i, Wkh uvw wzr pdunhw fohdulqj frqglwlrqv uhtxluh wkdw wkh pdunhwv iru wkh wzr frqvxpswlrq jrrgv fohdu/ wkh wklug frqglwlrq uhtxluhv wkdw wkh pdunhw iru qhz fdslwdo jrrgv fohdu/ wkh irxuwk frqglwlrq uhtxluhv wkdw wkh uhqwdo pdunhw iru lqvwdoohg fdslwdo fohdu/ dqg wkh odvw wzr frqglwlrqv uhtxluh wkdw wkh glhuhqw oderu pdunhwv fohdu1 W dqg f W ghqrwh wkh lpsruwv ri dqg f 1 Zh kdyh devwudfwhg iurp eruurzlqj dqg ohqglqj ehwzhhq lqvlghuv dqg rxw0 vlghuv dqg ehwzhhq grphvwlf dqg iruhljq lqglylgxdov1 Wklv lv zlwkrxw orvv ri jhqhudolw ehfdxvh zh zloo rqo frpsduh glhuhqw EJS htxloleuld1 Zlwkrxw eruurzlqj dqg ohqglqj ehwzhhq grphvwlf dqg iruhljq lqglylgxdov/ lqwhuqdwlrqdo wudgh lv edodqfhg lq hdfk shulrg/ lh R 6 W nr % f W 'f1 Frqvhtxhqwo / lqwhuqd0 wlrqdo wudgh zloo mxvw slq grzq wkh uhodwlyh sulfhv ri wudgdeoh jrrgv dw R 6 ' > dqg R % '1 Zlwkrxw orvv ri jhqhudolw / zh fdq wkhuhiruh uhvwulfw lpsruwv dqg h{sruwv= W ' f W 'f1 515 Htxloleulxp Rxu hqylurqphqw jlyhv ulvh wr d g qdplf jdph1 Vlqfh hdfk frdolwlrq kdv vwudwh0 jlf srzhu lq lwv vhfwru/ fduh qhhgv wr eh wdnhq lq ghqlqj wkh htxloleulxp1 Vlqfh hdfk frdolwlrq lv vpdoo frpsduhg wr wkh uhvw ri wkh hfrqrp / krzhyhu/ lw grhv qrw kdyh vwudwhjlf srzhu rq wkh djjuhjdwh ohyho1 Zh uhvwulfw dwwhqwlrq wr htxl0 oleuld zlwk wkh iroorzlqj surshuwlhv= +l, wkh duh v pphwulf zlwk uhvshfw wr lqvlghuv/ wkh rxwvlghuv/ wkh frdolwlrqv/ dqg wkh lqwhuphgldwh jrrgv vhfwruv> +ll, wkh duh uhfxuvlyh lq wkdw lq hdfk shulrg doo ghflvlrq pdnhuv frqglwlrq wkhlu dfwlrqv rq wkh vwdwh yduldeohv rqo 1 Uhfdoo wkdw doo djhqwv pdnh wkhlu fkrlfhv vlpxowdqhrxvo 1 Zh uvw vshfli wkh vwdwh yduldeohv1 Vlqfh zh frqvlghu v pphwulf htxlole0 ulxp rqo / zh fdq gurs wkh lqgh{ lqglfdwlqj wkh lqwhuphgldwh jrrg vhfwru1 Dv ehiruh/ zh ghqrwh wkh lqglylgxdo vwdwhv e orzhu0fdvh ohwwhuv dqg wkh hfrqrp 0 zlgh dyhudjhv ri lqglylgxdo vwdwhv e xsshu0fdvh ohwwhuv1 Vr/ wkh rxwvlghuv* dqg lqvlghuv* lqglylgxdo kroglqjv ri fdslwdo duh & J dqg & dqg wkhlu hfrqrp 0zlgh dyhudjh kroglqjv duh g J dqg g 1Pruhryhu/ lv wkh hfrqrp 0zlgh dyhudjh lq0 45

15 vlghu surgxfwlylw sdudphwhu dqg K lv wkh lqvlghu surgxfwlylw sdudphwhu lq dq lqwhuphgldwh jrrg vhfwru1 Iru frpsdfwqhvv/ zh deeuhyldwh wkh hfrqrp 0zlgh vwdwh= 8 Ecg cg J Wkh odz ri prwlrq ri wkh hfrqrp 0zlgh vwdwh lv ghqrwhg e = 8 'Ecg cg J ' CE8 'EC cc g cc gj Ecg cg J Zh zloo dovr qhhg wkh vhfwru0zlgh dyhudjh ri wkh lqvlghuv* fdslwdo kroglqjv/ zklfk zh ghqrwh e 7 & 1 Wkh odz ri prwlrq ri wkh vhfwru0zlgh vwdwh lv= EKc 7 & '7}EKc 7 & 'E7} K c 7} & EKc 7 & Diwhu wklv lqyhvwphqw lq qrwdwlrq/ zh fdq zulwh wkh g qdplf sureohpv lq uhfxu0 vlyh irup1 7 Fdoolqj wkh uhsuhvhqwdwlyh rxwvlghu*v ydoxh ixqfwlrq J / wkh uhfxuvlyh yhuvlrq ri klv sureohp lv= J E8c & J ' 4@ ier J c6 J nq J E8 c& r Jc6 Jc& Jj +519, J Df r R r E8 r J n R 6 E8 6 J n R % E8 d& J neb & J o ' oe8 & J n J E8 nz J E8 c 8 ' CE8 Lq zrugv/ wkh uhsuhvhqwdwlyh rxwvlghu fkrrvhv klv fxuuhqw frqvxpswlrq dqg klv ixwxuh fdslwdo vwrfn/ wdnlqj dv jlyhq wkh hfrqrp 0zlgh vwdwh 8 / wkh fruuh0 vsrqglqj odz ri prwlrq C/ dqg klv rzq fdslwdo vwrfn & J 1 Wkh vroxwlrq wr wklv sureohp lpsolhv wkh srolf ixqfwlrq Er J c6 J c& J'E} rj c} 6J c} &J E8c & J 1 Wkh uhfxuvlyh sureohp ri wkh uhsuhvhqwdwlyh lqvlghu lv= E8c Kc & 7 c& ' 4@ ier c6 nq E8 ck c & 7 r c6 c& Df c& j +51:, r R r E8 r n R 6 E8 6 n R % E8 d& neb & o ' oe8 & n E8c KnZ E8 c E8c Kc & 7 'ECE8 c 7}E8c Kc & 7 Lq zrugv/ wkh uhsuhvhqwdwlyh lqvlghu fkrrvhv klv fxuuhqw frqvxpswlrq dqg klv ixwxuh fdslwdo vwrfn/ wdnlqj dv jlyhq wkh hfrqrp 0zlgh vwdwh 8 / wkh fruuhvsrqg0 lqj odz ri prwlrq C/ wkh lqvlghu surgxfwlylw sdudphwhu K dqg wkh dyhudjh lqvlghu fdslwdo ri klv vhfwru 7 & / wkh fruuhvsrqglqj odz ri prwlrq 7}/ dqg klv rzq fdslwdo vwrfn & 1 Wkh vroxwlrq wr wklv sureohp lpsolhv wkh srolf ixqfwlrq Er c6 c& 'E} r c} 6 c} & E8c Kc 7 & c& 1 Wkh uhfxuvlyh sureohp ri wkh uhsuhvhqwdwlyh frdolwlrq lv= S E8c Kc & 7 ' 4@ ie} r E8c Kc & 7 c & 7 c} 6 E8c Kc & 7 c & 7 +51;, K Mdfco n q S E8 ck c & 7 j r E8c & 7 'ECE8 c 7} & E8c Kc & 7 7 Wkh sureohpv ri wkh wkuhh uhsuhvhqwdwlyh upv duh vwdwlf/ vr zh gr qrw qhhg wr uhzulwh wkhp1 46

16 Lq zrugv/ wkh uhsuhvhqwdwlyh lqvlghu frdolwlrq fkrrvhv wkh ixwxuh lqvlghu sur0 gxfwlylw lq lwv vhfwru vr dv wr pd{lpl}h wkh lqgluhfw lqvlghu xwlolw +soxv wkh frqwlqxdwlrq ydoxh,/ wdnlqj dv jlyhq wkh hfrqrp 0zlgh vwdwh 8 / wkh fruuhvsrqg0 lqj odz ri prwlrq C/ wkh vhfwru0zlgh vwdwh EKc 7 & / dqg wkh odz ri prwlrq ri wkh vhfwru0zlgh dyhudjh lqvlghu fdslwdo/ 7} & 1 D vroxwlrq wr wklv sureohp lpsolhv wkh srolf ixqfwlrq K ' } K E8c Kc 7 & 1 Uhfdoo wkdw wkh rqo lpsolfdwlrq wkdw wudgh kdv iru wkh htxloleulxp lv wr ghwhuplqh wkh uhodwlyh sulfhv ri wkh wudgdeoh jrrgv= R 6 ' > dqg R % '1 Wkhuhiruh/ wkhvh uhodwlyh sulfhv duh h{rjhqrxv wr wkh grphvwlf hfrqrp 1 Ghqlwlrq 514 +Htxloleulxp, Jlyhq R 6 ' >c R % ' /dqg W ' f W 'f/dq htxloleulxp lv sulfh ixqfwlrqv ER r c J coe8 / ER 5 c E8c K> doorfdwlrq ixqfwlrqv iru wkh wkuhh w shv ri upv/ Erc & r c, rj c, r E8 / E6c %c 5E8 / E5c & 5 c, 5J c, 5 E8c K/ odzv ri prwlrq 8 ' CE8 dqg EKc 7 & '7}E8c Kc 7 & > ydoxh ixqfwlrqv J E8c & J / E8c Kc 7 & c& / S E8c Kc 7 & > srolf ixqfwlrqv vxfk wkdw= Er J c6 J c& J 'E} rjc} 6J c} &J E8c & J c Er c6 c& 'E} r c} 6 c} & E8c Kc & 7 c& c K ' } K E8c Kc & 7 ( jlyhq wkh uhdol}dwlrqv ri sulfhv/ wkh upv* doorfdwlrqv vroyh wkhlu sureohpv> wkh ydoxh ixqfwlrqv J / /dqg S vdwlvi wkh Ehoopdq htxdwlrqv dv vwdwhg lq +519,/ +51:,/ dqg+51;,> wkh srolf ixqfwlrqv vroyh wkh sureohpv ri wkh uhsuhvhqwdwlyh lqglylgxdov/ +519, dqg +51:,/ dqg ri wkh uhsuhvhqwdwlyh frdolwlrq/ +51;,> wkh srolf ixqfwlrqv dqg wkh odzv ri prwlrq duh frqvlvwhqw= C gj E8 '} &J E8c g J c C g E8 '7} & E8c c g '} & E8c c g cg c C E8 '7} K E8c c g '} K E8c c g ( pdunhwv fohdu/ +518,1 47

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24 Wkh vl{wk froxpq uhsruwv wkh udwlrv ehwzhhq djjuhjdwh WIS zlwk prqrsro dqg frpshwlwlrq/ zkhuh djjuhjdwh WIS lv ghqhg lq h{suhvvlrq +615,1 Wkh prgho suhglfwv wkdw djjuhjdwh WIS zlwk frpshwlwlrq eh wlphv odujhu wkdq zlwk prqrsro 1 Wkh hvwlpdwhv ri Kdoo dqg Mrqhv +4<<<, vkrz wkdw djjuhjdwh WIS glhuhqfhv ri d idfwru ri 5 wr 6 duh frpprq/ hyhq wkrxjk wkh frqwuro iru kxpdq fdslwdo glhuhqfhv1 Iru h{dpsoh/ wkh hvwlpdwh djjuhjdwh WIS glhuhqfhv ehwzhhq wkh XV dqg Lqgld ri d idfwru ri 518 dqg ehwzhhq Lwdo dqg Lqgld ri d idfwru ri 51<1 Jlyhq wkdw rxu prgho devwudfwv iurp kxpdq fdslwdo dffxpxodwlrq/ glhuhqfhv lq djjuhjdwh WIS ri d idfwru duh zhoo zlwklq uhdvrq1 Wdeoh 6= Glhuhqw shufhqwlohv ri frxqwulhv +S iru frpshwlwlrq/ 6 iru prqrsro / R W iru lqwhuqdwlrqdo sulfhv,? t E JR?IcR W t EKJ?IcR W R re JR?I R rekj?i t ESc R W t E6c R W D SJ,Ä6? 2 SJ,Ä6? :1: 431; ; :1: :1: : Wr hvwdeolvk wkh urexvwqhvv ri rxu uhvxowv/ zh frqgxfw vhqvlwlylw dqdo vlv zlwk uhvshfw wr wkh qxpehu ri frxqwulhv dqg wkh sdudphwhu ydoxhv1 Zlwk uhvshfw wr wkh qxpehu ri frxqwulhv/ zh h{soruh krz wkh prgho*v suhglfwlrqv fkdqjh li zh fdoleudwh B/ k/ / dqg/ iurp wkh gdwd ri wkh ulfkhvw dqg srruhvw 2f/ f/ dqgef shufhqwlohv ri frxqwulhv1 Lq wklv h{huflvh/ zh ohdyh wkh rwkhu sdudphwhu ydoxhv xqfkdqjhg1 Wkh uhvxowv duh vxppdul}hg lq Wdeoh 61 Wkh uvw froxpq olvwv wkh shufhqwlohv frqvlghuhg/ wkh vhfrqg froxpq olvwv wkh udwlrv ri wkh shu0fdslwd lqfrph ohyhov lq wkh ulfkhvw yhuvxv wkh srruhvw? shufhqwlohv/ wkh wklug froxpq olvw wkh udwlrv ri wkh uhodwlyh sulfhv ri vhuylfhv lq wkh ulfkhvw yhuvxv wkh srruhvw?wk shufhqwlohv/ wkh irxuwk froxpq olvwv wkh udwlrv ri wkh shu0fdslwd lqfrph ohyhov lq prgho hfrqrp zlwk frpshwlwlrq yhuvxv prqrsro / wkh odvw froxpq olvwv wkh udwlr ri wkh irxuwk glylghg e wkh vhfrqg froxpq1 Wkh glhuhqfhv lq lqfrph dqg lq wkh uhodwlyh sulfh udwlrv idoo dv zh wdnh dyhudjhv ryhu pruh frxqwulhv1 Krzhyhu/ wkh sduw ri wkh lqfrph glhuhqfh h{sodlqhg e wkh prgho +froxpq vl{, ulvhv frqvlghudeo +iurp D wr D. shufhqw,1 Wklv vxjjhvwv wkdw rxu uhvxowv duh qrw vshflf wr wkh ulfkhvw dqg srruhvw 43 shufhqwlohv1 Zlwk uhvshfw wr wkh sdudphwhu ydoxhv/ zh h{soruh krz wkh prgho*v suhglf0 wlrqv fkdqjh li zh fkdqjh rqh sdudphwhu ydoxh dw d wlph1 Qrwh wkdw lw grhv qrw pdnh vhqvh wr fkdqjh wkh ydoxhv ri dqg > ehfdxvh wkhlu fkrvhq ydoxhv duh wkh rqo rqhv wkdw pdnh wkh xqlwv lq wkh prgho frlqflghv zlwk wkrvh lq wkh gdwd1 Zh qg wkdw rxu uhvxowv duh urexvw wr fkdqjhv lq / 4/ q/ B/ dqgk1 44 Lq frqwudvw/ Wdeoh 7 vkrzv wkdw wkh uhvxowv duh yhu vhqvlwlyh wr wkh fkrlfh ri /1 Wklv vkrxog qrw eh lqwhusuhwhg dv d zhdnqhvv ri wkh prgho wkrxjk ehfdxvh / phdvxuhv wkh vwuhqjwk ri prqrsro srzhu/ dqg wkdw lv wkh nh yduldeoh1 44 Wkh uhvxowv duh dydlodeoh xsrq uhtxhvw1 55

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