When Free Riding is Good

Frowned on Free Riding

 

 

Ditto

 

Free riding often reduces economic welfare by discouraging the production of public or collective goods.  A classic example is national defense.  If one individual invests resources in defending the nation from invasion, others will reap the benefits without contributing anything to such defense, thus free riding upon the first individual's investments.  If all individuals reason this way, none will invest in national defense, as each individual hangs back and waits for others to do so instead.  As a result, and because of this free riding, a private market will not produce an optimal level of national defense, that is, will not induce some investments in such defense that are cost-justified.  In these circumstances, only coercion by the State or other central authority can raise and expend the resources necessary to produce an optimal level of such defense.

Advertising and promotion by retailers provides a more mundane example.  Assume that a manufacturer sells its product to numerous independent dealers that serve the same base of customers.  Like individual expenditures on national defense, advertising expenditures by individual dealers will benefit several dealers, each of whom might benefit some from enhanced consumer interest in the product.   Like national defense, then, promotion and advertising of the good in question will be beset by free riding, as each dealer hangs back, hoping that other dealers will educate consumers, consumers that the shirking dealer who incurs no advertising expenses can attract with cut rate prices.   Various contractual arrangements known as intrabrand restraints can overcome this market failure and encourage more optimal levels and types of promotion and advertising, increasing the nation's output.  

 

However, a case currently before the U.S. Supreme Court illustrates how free riding can actually be good and how regulation designed to reduce such free riding can thus reduce society's economic welfare.  The case in question is Harris v. Quinn, No. 11-681.  (Go here for a collection of the briefs.) In Harris several individuals who provide in-home care for disabled persons, usually family members, are challenging an Illinois law that treats such individuals as employees of the State and coerces them to provide financial support to a union of public employees they do not wish to join.  Between 1985 and 2003, Illinois law sensibly provided that such individuals were not state employees at all, but instead independent contractors who provided services to patients whose care was reimbursed by the State.  However, in 2003 then-Governor and now convicted felon Rod Blagojevich, whose mugshot appears above, issued an executive order declaring such individuals to be employees of the State of Illinois.  (It should be noted that Mr. Blagojevich has appealed his conviction.)   The order paved the way for the unionization of thousands of such workers by a union that had contributed hundreds of thousands of dollars to Mr. Blagojevich's campaign.    The petitioners have declined to join this union, which has sought to compel them to contribute their "fair share" to the union's coffers.  The petitioners object to subsidizing an organization that will, under the aegis of collective bargaining, advocate higher government spending contrary to their political beliefs.
 

Illinois concedes that the First Amendment precludes it from forcing individuals, including union members, to support a union's political speech.   See Knox v. SEIU Local 1000, 132 S. Ct. 2277 (2012); Abood v. Detroit Board of Education, 431 U.S. 209 (1977).  However, it claims, with some support in Supreme Court precedent, that it may nonetheless compel non-union employees to provide financial support to subsidize a union's collective bargaining activities over wages, working conditions and the like.  While recognizing that such compulsion interferes with the liberty of non-union employees, the State nonetheless claims that such compulsion serves a "vital interest."  That is, Illinois contends that such coercion will prevent  "free riding" by employees who purportedly derive benefits from collective bargaining in the form of higher pay and enhanced benefits whether or not they pay fees to subsidize such bargaining.  (See pp. 45-48 of the State's brief, here.)

Illinois may well be correct that allowing employees to opt out of support for collective bargaining will result in free riding and thus smaller investments in collective bargaining and reduced wages and benefits.  Indeed, allowing such opt-outs could undermine collective bargaining altogether, as more and more employees realize they can decline to contribute to the union.   However, such a demonstration would not itself establish the wisdom of the coercion the State seeks to defend.  After all, some free riding increases the nation's welfare and thus should be encouraged.  Imagine, for instance, that the  Congress is considering new legislation that will prevent inefficient pollution.  Imagine further that the affected industries are fragmented and unable to organize effective opposition to the proposed legislation, because of free riding by the industry's firms on each other's lobbying efforts.  Such free riding will increase the nation's welfare by dampening opposition to beneficial legislation.
 

Shaky cartels provide another example of beneficial free riding.  Assume that an  industry's firms have entered a collusive agreement or engaged in tacit coordination that requires each firm to reduce its output 15 percent below what each would produce in a competitive market.  Judge Elbert Henry Gary, pictured above, famously orchestrated just such an arrangement between U.S. Steel and the rest of the steel industry early in the 20th century via so-called "Gary Dinners."  It is, of course, in the industry's collective interest for each firm to maintain that output reduction, thereby increasing prices above the competitive level and enhancing each firm's profits.  At the same time, each firm will have an individual incentive to cheat on the arrangement, secretly discounting its product slightly below the cartel price and increasing output, thereby taking advantage of the cartel price.

Such cheating is a form of free riding, as it depends upon an assumption that other firms are adhering to the agreement and thus maintaining output below and prices above the competitive level.  While such free riding will reduce the welfare of the industry by undermining collective output reduction, society should applaud this behavior, which will increase output, enhance the allocation of resources and increase society's economic welfare.

The example of the steel cartel sheds important light upon the social consequences of the sort of free riding Illinois is trying to stamp out.  According to Nobel Laureate George Stigler, and as previously noted on this blog, labor unions are simply cartels of employees.  George J. Stigler, The Theory of Price, 279 (4th Ed. 1987) ("The labor union is for the labor market the equivalent of the cartel for the product market.").    Moreover, unlike the steel cartel discussed above, labor cartels known as unions are perfectly lawful and thus more stable than cartels in the product market.  Indeed, the National Labor Relations Act, which the Supreme Court upheld in 1937, compels private employers to bargain with such cartels against their will.  As previously explained on this blog, such cartels deepened and lengthened the Great Depression and distort the allocation of human capital in the labor market by inducing firms to substitute capital for labor.  Given these anti-social consequences of unionization, wise public policy would encourage, and not discourage, free riding, for the same reasons that society would applaud free riding by members of a steel cartel and without regard to whether the prevention of "free riding" is a "vital interest" within the meaning of the Court's free speech jurisprudence.  A ruling that the Illinois scheme violates the First Amendment would thus have the incidental effect of encouraging such free riding and increasing the nation's welfare.


 

 

Do Powerful Unions Enhance Job Growth? Of Course Not!

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In a perplexing analysis in today's New York Times, entitled "In Wreckage of Lost Jobs, Lost Power," David Leonhardt manages to turn both microeconomics and macroeconomics on its head, claiming, as he does, that stronger unions would somehow result in faster job growth and faster economic recovery. In so doing, he channels some of the discredited arguments that FDR and others made in favor of state-backed cartelization, including cartelization of labor, during the 1930s. Here are some excerpts of Leonhardt's analysis.

"But beyond these immediate causes, the basic structure of the American economy also seems to be an important factor. This jobless recovery, after all, is the third straight recovery since 1991 to begin with months and months of little job growth. . . . .

Why? One obvious possibility is the balance of power between employers and employees."

Later in the piece Leonhardt claims that:

"Study after study has shown that unions usually do benefit workers."

and

"For all their shortcomings, unions remain many workers’ best hope for some bargaining power."

Leonhardt does not explain how stronger unions and resulting "bargaining power" would speed job growth. "Union bargaining power" is simply a synonym for market power over the price of a very important input --- labor. Presumably unions would use such power to increase wages and/or foist other unwanted conditions of employment on employers. Because there are substitutes for American labor --- capital, foreign labor, or both, policies that raise the price of American labor will predictably cause firms to purchase less of it, either by substituting capital for such labor or exporting jobs to countries where wages are lower. (Moreover, foreign investors may choose not to invest here in the first place.) This is just basic microeconomic price theory, and Leonhardt offers no argument or evidence that the basic rules of price theory do not apply in this context. While unions may benefit workers who retain their jobs despite the wage-raising exercise of bargaining power, such a conclusion does not suggest that unions increase employment. Quite the contrary. The very exercise of bargaining power that raises wages and makes some employees better off also makes labor more expensive and causes firms to purchase less of it.

It should be noted that America experimented with the sort of policies Leonhardt advocates in the early 1930s. In 1933, Congress passed and FDR signed the National Industrial Recovery Act. The NIRA allowed firms, via trade associations, to adopt so-called "Codes of Fair Competition," and the NIRA required such codes to include provisions raising wages above the competitive level, as a means of stimulating the "purchasing power" of workers and thus jumpstarting recovery. However, none other than John Maynard Keynes suggested, in an open letter to President Roosevelt in the New York Times, that the N.I.R.A. "probably impede[d] recovery" by artificially raising wages and prices. According to Keynes, policies that stimulated aggregate demand would raise wages and prices, and not the other way around. Over a decade ago your not-so-humble blogger argued that the N.I.R.A. and other policies that raised wages and prices slowed the recovery from the Great Depression. See Alan J. Meese, Will, Judgment and Economic Liberty: Mr. Justice Souter and the Mistranslation of the Due Process Clause, 41 W. & M. L. Rev. 3, 48-49 (1999) (contending that the N.I.R.A.’s wage and price fixing likely exacerbated the Depression and slowed economic recovery).

Modern economists agree with Lord Keynes that the N.I.R.A.'s state-enforced cartelization of industry and labor impeded recovery. Thus, Christina Romer, immediate past Chair of President Obama's Council of Economic advisors, conluded that the NIRA "prevented the economy’s self-correction mechanism from working." See Christina D. Romer, Why Did Prices Rise in the 1930s?, 59 J. Econ. Hist. 167, 197 (1999). Moreover, writing in the Journal of Political Economy, economists Harold Cole and Lee Ohanian conclude that the N.I.R.A. and other New Deal policies, including the National Labor Relations Act passed in 1935, substantially prolonged recovery and inflated unemployment. See 112 J. Pol. Econ. 779 (2004) (For a prior version of the paper, go here.) Indeed, the article expressly identifies labor union "bargaining power" and resulting high wages as a culprit holding back recovery.

FDR, of course, did not have the benefit of the Cole/Ohanian/Romer analysis, thereby mitigating somewhat his responsibility for the unemployment and slow recovery that his policies wrought. Modern commentators who advocate such policies have no similar excuse.

Flawed Arguments For Unionization From Maine

In a recent editorial, the Portland Press Herald has endorsed pending legislation in Congress that would purportedly make it easier for employees to form unions, against the wishes of their employers. Here is a link to the Op-Ed.

Here is the core of the paper's argument for this legislation:

"For decades, middle-class wages have been stagnant and union membership has been in decline. The trends are connected. America has been losing the industrial manufacturing jobs which were once the stronghold of organized labor. The result can be felt throughout the economy. Union members are better paid and are more likely to have employer-supplied health insurance and pension plans than non-union employees. Non-union workers in communities with strong unions are better paid than similar workers in other areas. The importance of unions has been recognized in federal law since the 1930s. But organizing today's workers in service sectors, like high-tech and medical industries, will take some changes to the rules that were put in place to govern organizing factory workers many decades ago."

In other words, unionized workers earn more than non-unionized workers, so "reform" that encourages unionization over the objection of employers is a good thing. This is a very common argument for unionization and legislation that facilitates it.

There are, however, several flaws in this all-too-common argument. Here are three.

First, the observation that unionized workers earn more than their non-union counterparts may simply reflect the fact that unions are more likely to organize workers in high wage industries. Campaigns to unionize a workforce can be expensive, and unions can only recoup their expenses by charging workers who choose to organize union dues, dues that are presumably higher in high wage industries, where workers can afford such levies. As a result, unions may choose not to unionize low wage industries in the first place, thereby explaining the gap between wages for union and non-union workers.

Second, the data invoked do not, contrary to the editorial's assertion, indicate that unions make workers in unionized industries better off than they otherwise would be. While unionization may raise the wages (and benefits) of some workers, such wage increases will cause employers to substitute capital for labor, thereby employing fewer workers now and in the future and reducing overall employment. Such adjustments will be more pronounced in the longer run, as capital wears out and firms thus have more flexibility to adopt capital-intensive production processes. In some cases, industries may shut down altogether because of competition from foreign firms with lower labor costs. (Indeed, the editorial does not seem to recognize that America has been losing manufacturing jobs precisely because unionization of such industries artifically raises the cost of labor. Instead, the editorial seems to treat the failure of these industries and resulting reduction in manufacturing employment as an argument for encouraging unionization elsewhere !) Thus, while the wages of some workers may rise as a result of unionization, the wages of others may fall to zero, at least until these laid off workers obtain less remunerative employment elsewhere. Studies purporting to show that unionized workers, who are by definition employed, earn more than others, do not account for the negative impact of unionization on those who, because of unionization, are now former employees.

Third, even if additional unionization will increase the overall welfare of some employees, one still needs additional argumentation to support such legislation. Higher wages and benefits are not free. Firms and/or their customers must pay for such additional labor costs. Thus, legislation that encourages unionization may simply transfer income from one set of middle class workers and business owners to others. To be sure, unionization may in some instances increase the productivity of employees by, for instance, facilitating the negotiation and enforcement of efficient and complex contracts between labor and management. However, if the efficiency benefits of unionization entirely offset the increased wages resulting from unionization, then employers would embrace unionization, thereby obviating the need for such legislation. Absent some convincing argument that unionized workers deserve increased wealth more than employers and their customers, the editorial's argument fails on its own terms.

President Obama Repeals Order That Informed Workers of Their Rights

The Chicago Tribune reports that President Obama has signed an Executive Order reversing a Bush Administration rule that required businesses to notify workers of certain rights under Federal Law. At issue is a worker's right of a refund of compulsory dues payments that the Union wishes to use for political advocacy, and not collective bargaining. President Bush recognized the right in Executive Order 13201, which required certain federal contractors to post a notice that workers possess such rights.

Here is Executive Order 13201 and the order that, among other things, repeals it:

http://www.presidency.ucsb.edu/ws/index.php?pid=61483

http://www.shopfloor.org/wp-content/uploads/2009fedlaboreorel.pdf

Here is the story in the Tribune:

http://www.chicagotribune.com/news/politics/sns-ap-obama-labor,0,1774304.story

In Communications Workers v. Beck, 487 U.S. 35 (1988) the Supreme Court, in an opinion by Justice Brennan, held that Federal Labor Law requires Unions to provide pro-rata refunds of compulsory dues to employees who object to particular political expenditures. Hence, a liberal democrat union member can receive such a refund if his union endorses Ronald Reagan and attempts to use compulsory dues to fund an advertising campaign in his favor. Beck relied by analogy upon earlier decisions that read similar statutes narrowly to avoid First Amendment questions that would be raised by state ation compelling individuals to support political causes to which they objected. Indeed, in Abood v. Detroit Board of Education, for instance, the Court held unanimously that Michigan could not compell public employees to pay union dues that were then used for political purposes. The Abood Court quoted the admonition of Thomas Jefferson that the state ought not coerce individuals into supporting ideas they abhor.

According to Jefferson: "to compel a man to furnish contributions of money for the propagation of opinions which he disbelieves, is sinful and tyrannical.'"

Of course, Abood itself only applies in cases in which there is state action compelling unionization, thus bringing the Bill of Rights into play. Decisions such as Beck read similar principles into Federal Labor Law that applies to bargaining agreements between purely private enterprises and their employees.

You might not know any of this from the Tribune's story (or any others that I could find). Instead, the current version of the Tribune story describes the order by stating that it would

"Reverse a Bush administration order requiring federal contractors to post notice that workers can limit financial support of unions serving as their exclusive bargaining representatives."

Given what was involved in Beck, this seems like an incomplete description of the impact of President Obama's order. Failure to support a union's political speech and electioneering is not the same thing as "limit[ing] financial support of unions." Even under the now repealed Executive Order 13201, employees in agency shops could be compelled to support the Union's collective bargaining activities, even if they were not members of the union.