Discussion Review 3
1. What is collective action failure? What is the solution to this problem? Use wage restraint as an
Collective action failure refers to the consumption of public goods where the individual contribution is
negligible such that there is a strong incentive to free ride
There are two conditions:
1) Output is public good; that everyone has access to good
2) Output relies on collective contribution of all members but contribution of each individual is negligible
1) Make output private
2) Decrease the number of contributors so cost to free ride is higher
Wage restraint satisfies both conditions of a collective action failure
1) It’s a public good. Wage restraint leads to low inflation. Low wages also make the nation more export
2) It depends on the collective action of all firms/unions involved, but the contribution of any individual
firm is negligible so unions will try to maximize wages
The solution here is to merge unions (decrease # of contributors)
2. Wage bargaining can be centralized or decentralized. What type of bargaining leads to the
highest unemployment? Extreme centralization: Unions have partnerships with firms so they do not demand high wages; with
more profit, firms can hire more people; this leads to lower unemployment
Moderate centralization: Unions demand high wages and they have sufficient collective power to do so,
so they free ride; with less profit firms can hire less people; this leads to higher unemployment
Extreme decentralization: Unions demand high wages, but because they are so decentralized they have
low bargaining power so employers refuse to give high wages; this leads to low unemployment
3. What is the “social wage”? Why was the “social wage” abandoned after the 1970s?
Social wages are welfare benefits/services that the state provides to entice workers to give up high wages.
Unlike market wages which are paid by companies, social wage is paid by workers through taxes. This
exploits the rational behaviour of “time discounting” (ie. workers are hurt in the long run). Thus, this
doesn’t increase unemployment.
When the economy is growing fast, output is large and there is enough tax revenue to sustain generous
social wages. But when the economy slows down, such as it did in 1970s, output is small and more tax
revenue is needed to sustain the same level of social wages. Thus, social wages were abandoned here.
4. What is Baumol’s cost disease? Can wage equality help cure the cost disease?
Baumol’s cost disease is when wages in the low wage sector are contaminated by high productivity, high
wages service sector. For example, although wages for musicians have increased, their productivity hasn’t. To keep workers
from leaving, firms offer higher wages even though their productivity is low.
Key point is: increase in wages is not due to increase in productivity but due to higher wages in other
Wage equality would make bottom end job wages higher for the same level of productivity. This means,
low wage jobs are even closer to the higher wage jobs. Thus, wage equality exacerbates baumol’s cost
5. The 1970s ushered in a period of transition towards the service economy. The size and quality of
the service economy, however, is very different across countries. Can you explain this cross-country
Anglo Saxon nations
• large private service sector
• lots of low skilled, low wages, junk jobs
• low taxes
• example: daycare, babysitter, hamburger flipper
• large public sector
• high quality jobs funded by higher taxes
• example: state licensed daycare
• Wages are pretty equal so can’t have private service sector jobs
• By principle of subsidiarity welfare services are delivered by family not state, so small public
• low taxes
6. What is the tri-lemma of the service economy?
There are three objectives that nations try to reach.
1) Job growth
3) Low taxes Anglo Saxon nations achieve job growth and low taxes but not wage equality.
Scandinavian nations achieve job growth and equality but not low taxes.
Continental European nations achieve equality and low taxes but not job growth.
Tri-lemma is such that a nation can succeed in any two of these three objectives.
*Note: Manufacturing doesn’t face trilemma
7. What is the effect of wage restraint on employment? What is the effect of wage compression on
Wage restraint leads to higher profits for firms which lead to higher employment.
Keep at reasonable level as long as wage does not exceed level of productivity
Lower wage = inc. rev = more employment b/c more money hire people
Wage compression worsens baumol’s cost disease. It leads to lower employment.
wages equalized - higher wages lowered, lower wages increased
8. What do we mean by “Varieties of Capitalism”?
There are two varieties of capitalism:
CMEs and LMEs
Coordinated Market Economies - Scandinavian and Continental European nations
• Centralized cohesive economic players
• Trade federations, unions
• Deep, long term, large equity/investors own shares
• Cross share holdings between companies
Firm-Firm: prevent skill poaching
Firm-Worker: wage restraint for deeper training
Firm-Investor: patient capital, large share owners where success of the company is tied to the success of
Liberal Market Economies -Anglo Saxon nations
• Segmented, non-cooperative economic players
• Shallow and short term relationships
Firm-Firm: rampant poaching Firm-Worker: conflict, workers demand higher wages but firms won’t give it and won’t provide workers
Firm-Investor: impatient capital, investors are minority shareholders who want to flip the stock as soon as
9. Why didAnglo-Saxon countries fall behind Europe and Japan in technological innovation?
Surge from behind (copy what works): Post WW2, European nations and Japan copied technology from
more advanced,Anglo Saxon nations. This backward learning allowed them to rebuild very quickly.
There are two ways they did this:
1) Reverse engineering - Bought piece of technology and learned how it works. The knowledge is
embodied in the product. This is what Japan did.
2) Patient disclosure - Buy patents, hire scientists (disembodied). This is what China did.
Decline from above:
Two types of innovation: radical (for example biotech) and incremental (improved car model)
Radical innovation is novel, but low quality when it comes out. It has a temporary monopoly.
Incremental innovation is old, but high quality.
LMEs excel at radical innovation. So bleeding edge of scientific discoveries.
CMEs excel at incremental innovation. They depend on deep, industry specific skills.
Anglo Saxon nations fell behind because radical takes time to develop compared to incremental
10. How do advanced industrialized countries compare in the quality of their human capital? Please
explain both academic education and trained skills.
CMEs make niche, high quality products. LMEs make low quality, cheap, mass consumer products. CMEs have deep Firm-Firm, Firm-Worker and Firm-Investor relationships. With patient capital, little risk
of skill poaching, they provide workers with deep, specialized training.
LMEs have fragmented, short and shallow Firm-Firm, Firm-Worker and Firm-Investor relationships. With
just impatient capital and risk of poaching disincentivises firms from training their workers.
Anglo Saxon workers have few skills (from earlier discussion). This means job applications take actions
too costly for low productive people to do. This involves getting higher and higher degrees because
people need to signal quality (rat race). In the end, people get over-educated for a particular job.
Moreover, since LMEs have residential based schooling, when rich flock to a particular area, housing
prices go up. This signals more rich people to come there. So rich get high quality high school education.
Similarly, the poor people take up the houses that the rich left and all poor people go to the same school;
they get poor education.
Workers in CMEs have sufficient skills, so they don’t need to get higher and higher degrees. Job training
prevents rate race for CMEs.
11. What is solidaristic wage policy? What is active labor market policy? How may such policies
contribute to economic growth? Is the solidaristic wage policy effective in a service economy?
Solidaristic wage policy is when wages are equal regardless of productivity. This forces out the least
productive firms out of the market and creates more profit for the higher productive firms (which allows
them to hire more people). This creates a nationwide incentive to be more productive.
Active labor market policies help training workers to bring them back into the labor force. (only for
Solidaristic wage policy only works for manufacturing type jobs and not for service sector jobs because