BANK OF FINLAND DISCUSSION PAPERS

BANK OF FINLAND DISCUSSION PAPERS 7 2004 Berthold Herrendorf Arilton Teixeira Research Department 24.2.2004 Monopoly rights can reduce income big time Suomen Pankin keskustelualoitteita Finlands Banks diskussionsunderlag

Suomen Pankki Bank of Finland P.O.Box 160 FIN-00101 HELSINKI Finland + 358 9 1831 http://www.bof.fi

BANK OF FINLAND DISCUSSION PAPERS 7 2004 Berthold Herrendorf* Arilton Teixeira** Research Department 24.2.2004 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 BEC2000-0170) and from the Instituto Flores Lemus (Universidad Carlos III). * Universidad Carlos III de Madrid, Departamento de Economía, Calle Madrid, 126, 28903 Getafe (Madrid), Spain; University of Southampton; CEPR. E-mail: herrendo@eco.uc3m.es. ** Ibmec, Department of Economics, Av. Rio Branco, 108/12o. andar, Rio de Janeiro, RJ, 20040-001, Brazil. E-mail: arilton@ibmecrj.br. Suomen Pankin keskustelualoitteita Finlands Banks diskussionsunderlag

http://www.bof.fi ISBN 952-462-126-6 ISSN 0785-3572 (print) ISBN 952-462-127-4 ISSN 1456-6184 (online) Multiprint Oy Helsinki 2004

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

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

Contents Abstract...3 Tiivistelmä...4 1 Introduction...7 2 Model economy...9 2.1 Environment...9 2.2 Equilibrium...12 3 Analytical results...15 4 Quantitative results...18 5 Discussion...23 6 Conclusions...26 References...28 Appendix A Derivations and proofs of the propositions...31 5

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