The Breakdown of the Capital-Labor Accord and Okun’s Law

I’ve been thinking a lot lately about the periodization of recent history and its connection to economic theory. In particular, in economic sociology we talk a lot about the “post-war capital-labor accord” and the golden age of the 1940s-1970s. In these years, inequality went down, unions flourished, civil rights laws were passed along with LBJ’s Great Society programs like Medicare, etc. Corporations saw themselves as not just profit-seeking nexuses-of-contracts but also as institutions with duties to their stakeholders – employees, local community organizations, etc.

Then everything went to hell in the 1970s. Oil shocks, poor economic performance, large increases in foreign competition, an overheated economy created by the meeting of increased social spending and increased military spending, all combined to create massive inflation and other sorts of economic upheaval. The shooting war between labor and big business resumed, as union contracts were blamed for causing inflation and big business began to push for regulatory changes (to fight the hated EPA and OSHA, along with unions) and increased layoffs. Institutional investors, growing rapidly in size in part *because* of the prosperity of the “golden age” (e.g. the massive pension funds like CALPERS and TIAA-CREF), began to demand discipline from corporations unused to having to listen to anyone (cf. Berle and Means 1932, Useem 1996). Changes in financial regulations and institutions made possible the junk bond market and, in turn, a more active market for corporate control – suddenly, large firms that were used to making acquisitions became targets.

In short, by the mid-1980s, the golden age had ended along with the capital-labor accord and something new had begun – perhaps we can call it the “neoliberal era” for lack of a more imaginative term (and recognizing that “neoliberal” is an absurd term that often sheds more heat than light). This era’s hallmarks include the dramatic decline in unions, massive increases in the share of wealth going to the top 1% and .1% (cf. Piketty and Saez), massive increases in the share of profits going to finance (cf. Krippner 2005), and an overall change in the way that corporations perceived themselves. No longer institutions with obligations beyond profit-seeking, corporations became (thought of as) legal fictions that served the sole purpose of maximizing shareholder value (cf. Davis 2009)*. The old dominant strategy of firms was to “retain and reinvest”, the new mantra was to “downsize and distribute” (Lazonick and O’Sullivan 2000). The old model of the firm was GM – a massive, vertically integrated institution that dominated a market and did everything in-house. The new model was the “Original Equipment Manufacturer” (OEM), a firm like Nike that designs a product and markets it but outsources and off-shores as much of the actual producing, distributing, etc. The firm is now a brand, an identity demarcating a certain set of contracts, whose value is more about intangibles than men and machines.

So what’s all this got to do with Okun’s law? And what, exactly, is that anyway? Okun’s Law is an economic relationship between the magnitude of an economic downturn (in terms of real GDP) and increases in unemployment. Here’s Brad DeLong’s version from a recent piece on jobless recoveries (which I’ll talk about a bit more below):

Back in the 1960s one of President Johnson’s economic advisors, Brookings Institution economist Arthur Okun, established a rule of thumb quickly named “Okun’s Law.” Here is the gist: if GDP (production and incomes, that is) rises or falls two percent due to the business cycle, the unemployment rate will rise or fall by one percent. The magnitude of swings in unemployment will always be half or nearly half the magnitude of swings in GDP.

Okun’s law did a pretty good job, as I understand it, of describing the GDP-unemployment relationship throughout the period of the capital-labor accord, but began to break down after 1980. The last downturns – 1991ish, 2001ish and the current moment – have all been characterized by “jobless recoveries” or, more broadly, much larger decreases and much smaller increases in unemployment than would be predicted by Okun’s law. DeLong lists four reasons why unemployment used to drop less than GDP, but the essential one for my argument is the first, that “businesses will tend to “hoard labor” in recessions, keeping useful workers around and on the payroll even when there is temporarily nothing for them to do”. DeLong goes on to make a cultural argument for why this factor no longer applies:

Manufacturing firms used to think that their most important asset was skilled workers. Hence they hung onto them, “hoarding labor” in recessions. And they especially did not want to let go of their prime productive asset when the recovery began. Skilled workers were the franchise. Now, by contrast, it looks as though firms think that their workers are much more disposable—that it’s their brands or their machines or their procedures and organizations that are key assets.

I think DeLong is right**, and I think recent economic sociology has a lot of evidence to back up his intuition. There has been a tremendous shift in both the institutions surrounding corporate action (e.g. the neutering of the NLRB by Reagan, the deregulation of financial markets, the rise of institutional investors) and, along with those institutional shifts, dramatic changes in the way corporations think of and justify themselves. The 1980s saw a reordering of the world – a transition from a period governed by one set of rules that privileged the relationship between businesses and their employees to one that privileged (relatively speaking, in ideology anyway) shareholders.

Okun’s law is not (and I don’t think ever pretended to be) a transhistorical statement about the relationship between output and employment; rather it was a parameter of a certain moment in history, a certain matrix of institutions and actors and ideas. Our new era is one of “jobless recoveries” and rising inequality. Perhaps, this new moment will make us question the idea of recovery itself – what exactly is recovering if things seem to get worse, not better, for the typical worker (and that fewer and fewer people are working at all)? What variables should we care about, if GDP seems to be connected less to welfare than it used to be?

* Ironically, the nexus-of-contracts view of the firm derives (in part) from financial economics’ agency theory, whose main concern was disciplining managers to not run away with the firm’s valuable assets and profit-making opportunities and instead focus on making money for the shareholders. Yet the neoliberal period is marked by dramatic, mind-boggling increases in executive compensation without, as far as I know, any signs of better performance or increased shareholder value. Counter-performativity much?
** I find myself saying this a lot these days. I hope they don’t take away my economic sociologist card! We only have to disagree with some economists – right?

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4 Comments

  1. laborlawguy

     /  July 27, 2009

    Very perceptive and neutral in tone, well done.

  2. Sean Safford

     /  July 28, 2009

    “Okun’s law… was a parameter of a certain moment in history, a certain matrix of institutions and actors and ideas.”

    I think this is a useful insight, worthy of discussion. One way to think about is essentially paradigm-oriented: Laws in social science last only as long as the social order or era with which they are associated prevails.

    Another, of course, is that the last few years have been an anomaly; i.e., that we lived through a “balanced” economy for some period of time, but that it has gotten out of whack. Once we return to a stable equilibrium, our “laws” will work properly again.

    This video from the economist doesn’t answer the question, but raises the issue in a usefully graphic way: http://www.facebook.com/ext/share.php?sid=109163441876&h=oPsC-&u=gdUc8&ref=mf

  3. Thanks Sean! That is a fantastic video. I wonder, though, if those aggregate statistics miss much of the interesting parts of the story, especially ones relevant to the discussion of Okun’s law. It’s not simply that the ratio of spending to saving has changed in the past few decades, but also the distribution of resources, along with technological change and increased trade in different sectors. There are surely links between these trends, but I wonder if we can imagine an equally “unbalanced” growth counterfactual for the last 25 years that did not disfavor labor so much, and that did not break apart the social forces behind Okun’s Law (or found new ones to replace them).

    I’m highly skeptical of the idea of the last few years being an anomaly, as even if some of the observed relationships of the preceding era start describing the world a bit better in the near future, it will be through new combinations of institutions, actors, industries, etc. not the restoration of an old order. I’m also just highly skeptical of economic laws applying over too long stretches of time or space.

  4. Neil in Chicago

     /  August 23, 2009

    ((I came in through your comment to Carlie Stross.))
    I would like to submit my own idea of the transition of the 70’s.
    At the end of WW II, the U.S. had most of the remaining industrial plant left in the world. It took the various other industrial powers, who still had most of their social and educational infrastructure, a generation to recover. The first OPEC Oil Shock, in 1973, began the return to normalcy.
    From the beginning of industrialization through WW II, there was borderline class warfare in the United States. (I’m a Chicagoan . . . Haymarket, Pullman, Republic Steel . . . Homestead, Ludlow, Seattle General Strike) Besides advances in sciences and technologies, a lot of what has happened in the last 35 years is due to much stronger institutional memory on the Right than the Left.

    A second point is the vital role of lack of introspection on the Right and their minions. It’s transparently obvious, for example, that sexual hysteria is a vital motivator, but it doesn’t seem to be recognized by its victims.

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