The Productivity Puzzle and the Decline of Unions

For nearly four decades in the post-War United States, average labour productivity and total factor
productivity remained procyclical — falling during recessions and rising in booms. Productivity puzzle refers to the sudden vanishing of this procyclicality of productivity during the mid-1980s. This paper argues that increased labour market flexibility, as manifest in rapid de-unionization, can help explain the puzzle. Declining costs of hiring and firing workers due to the fall in union power prompted firms to rely more on employment adjustment instead of intensive margin changes in workers’ effort through labour hoarding. Since labour hoarding explained procyclicality of productivity historically, lower dependence on it in recent decades made measured productivity less procyclical. Cross-sectional evidence from U.S. states and industries, as well as the changing responses of the aggregate U.S. economy to technology and demand shocks, bear out this mechanism. Allowing the hiring cost to change between pre and post-1980s in an otherwise standard New Keynesian model with endogenous effort is shown to match the empirical patterns in productivity
moments quite well.