The history of the Rust Belt, a swath of states running from New York to Wisconsin that borders the Great Lakes, was the focus of one session of the Midwest Macroeconomics meetings, a premier conference where relatively young macroeconomists gather to share cutting-edge research, which was held May 16-19 at the University of Illinois in Urbana, Ill.
Lee Ohanion, a professor at UCLA, made the presentation regarding the region which in early U.S. history was often referred to as the “manufacturing belt” as it was associated with heavy industries such as steel, automobiles and mining.
Part of the reason for the area's early economic success was the presence of solid infrastructure in the form of railroads, canals, and navigable rivers that made the transport of manufactured goods relatively easy. After the Civil War, workers flooded into the area, both from overseas and from other parts of the U.S. Since the end of World War II, the area's share of U.S. industrial production has fallen dramatically. This, in turn, has led to decreases in the population of once booming factory cities as workers have moved elsewhere to find jobs. Some Rust Belt cities like Detroit have become poster children for urban decline. Others, such as Pittsburgh, have reinvented themselves as technology hubs. Many are somewhere in between the two extremes. The overall decline of industry in the region has been slow and steady and cannot be attributed to a single historic event.
Ohanion’s research question was, “how much of this decline was due to the unique economic conditions that prevailed in the region?” To answer this question he built a dynamic model that incorporates the main features that distinguished the Rust Belt from the rest of the U.S. In this context, dynamic simply means that the economic conditions of the model are changing over time. This is due to events outside the scope of the model, which are termed “exogenous.” It is also due to the responses of economic agents — workers, companies, etc. — to the current and expected future state of the economy, which are termed “endogenous.”
Ohanion sets up his model by assuming that at the end of World War II, the Rust Belt had two major differences with the rest of the U.S. First, industries in the Rust Belt held a competitive advantage over potential rivals. He models this by assuming that established firms in Rust Belt industries could obtain a competitive advantage over potential competitors by paying a relatively small research and development cost. Firms in other areas of the country are assumed to have less of a competitive advantage and must pay higher costs to gain the same level of advantage. This assumption is meant to capture the unique legacy of industrial supremacy the region enjoyed in the late 1800s and early 1900s.
This competitive advantage leads to above average profits, or “rents” as they are referred to in economics. The second assumption he makes is that workers, through labor unions, were able to extract a significant portion of these rents via bargaining.
He then shows that given these initial conditions, the inevitable path of Rust Belt economies is one of declining investment in research and development and a loss of industrial production share to the rest of the U.S. His best estimate is that roughly half of the observed decline is due to this mechanism.
Not surprisingly, how quickly industry shares decline in his model depends on how long the leading firms in the Rust Belt believe they will enjoy a competitive advantage. Ohanion assumes that the long-run trend across the U.S. is toward a decline in labor union bargaining power and a decline in monopolistic rents. When firms expect this decline to be slow and drawn out, there is little investment in technology. On the other hand, when the decline is expected to occur more rapidly, companies have a greater incentive to improve their long-run efficiency by investing in technological advances.
One of the driving forces in the Rust Belt’s decline is the cozy relationship the market structure encouraged between firms and labor unions. When firms lack serious competition and monopolistic rents are relatively easy to earn, it is easier for unions to extract a percentage of those rents. This leads inexorably to a drop in technological investment by firms and, in the long-run, to a loss of production as the price of Rust Belt goods rises relative to goods produced elsewhere in the U.S.
Kerk Phillips is an associate professor of economics at Brigham Young University. His views do not necessarily represent those of BYU.