The Decline in Construction Employment, Infrastructure Investment and the Davis Bacon Act

Reihan Salam has a smart piece in National Review Online and provides some good insights about how the construction sector is changing and why construction employment has not rebounded as it has in prior recoveries.  He notes that modular construction and technological change is likely to change the labor intensity of construction projects.  So even when construction activity rebounds, construction employment may never regain the share of total employment it reached during the housing boom of a decade ago.  Salam is correct; trends in construction employment may begin to look a bit more like manufacturing.  In U.S. manufacturing it has been quite common to see output increase despite stagnant or even declining employment because of technological change.

Salam writes that construction projects in the U.S are often inefficient and I agree, especially when it comes to infrastructure investments.  The federal regulations make public sector projects far too expensive to taxpayers even at a time when a record downturn in construction employment should mean much lower costs.  The federal government has not taken enough advantage of the considerable slack in construction employment to build and repair infrastructure.

By law, federal government projects must pay the prevailing wages of construction workers, and these wages are often union scale.  This regulation, known as the Davis Bacon Act, has artificially inflated the price of construction labor on public sector projects.  Even in states and counties  where construction employment has been depressed for the past five years, government contractors are sometimes required to pay wages in construction trades that exceed the average in the area by at least $10 per hour.

Davis Bacon wages do not rely on carefully designed samples of workers, such as the Bureau of Labor Statistics (BLS) Occupation Employment Statistics (OES) Survey to determine the wage distribution in construction trades in a local area.  Instead, Davis Bacon wages are determined in the Labor Department’s Wage and Hour Division which over-samples unions and obtains much higher construction wage estimates.  Only 6.6% of private sector workers are union members so the special treatment of unions in Wage and Hour Division surveys leads to unrepresentative prevailing wage estimates.

As an example consider Riverside County, California where the unemployment rate in July was 11.1%.  The most recent OES survey reports that the average wage for a carpenter is $27.25 per hour and 75% of carpenters earn $36.39 per hour or less in Riverside.  Yet the Davis Bacon Act mandates that federal contractors pay at least $48.43 per hour to carpenters in Riverside, in wages plus fringe benefits, on government construction projects.  The Davis Bacon prevailing wage for carpenters is $37.35 per hour and prevailing fringe benefits are $11.08 per hour.  (The BLS National Compensation Survey reports that the average cost of fringe benefits is $10.52 per hour nationwide.)  Similarly inflated compensation is required for brick masons, electricians, plumbers and equipment operators.

Although reasonable economists can disagree about the level of public spending on infrastructure, ideally we should make more public investments in infrastructure during a downturn when opportunity costs are lower.  The Davis Bacon Act interferes with such a common sense policy.  Conservatives should have proposed a repeal of Davis Bacon in the waning months of the Bush Administration or early in the Obama Administration as a way to more efficiently utilize slack resources during the recession.

Requiring taxpayers to pay inflated prices to construction labor makes as much sense as paying inflated interest rates to government bondholders even though market interest rates have declined.  The federal government currently pays lower interest rates on government debt because it pays market rates on new debt issues.  Fortunately there is no equivalent to the Davis Bacon Act requiring that the federal government pay inflated non-market interest rates to protect retirees and pension funds that hold government bonds.  It is time to change the law so that taxpayers can also pay market wages on construction projects.

Will Michigan’s Right-to-Work Law Mean Larger Declines in Union Membership?

Michigan is about to become the 24th state with a “right-to-work” law.  A “right-to-work” law makes union dues voluntary by prohibiting closed union shops in the private sector.  In a closed shop workers represented by a union are compelled to pay union dues.  Once the law is signed in Michigan, workers represented by new collective bargaining agreements are free to decline paying union dues.   The Michigan law would make existing union-employer agreements exempt from the prohibition on closed shops.  An argument in favor of the Michigan law is that companies considering alternate locations for a new plant, factory or facility will face the same right-to-work environment in Michigan as in southern and western states.  For those who believe that states in the industrial Mideast have lost jobs in capital-intensive industries because of differences in labor laws, this law makes Michigan more competitive.  It is also notable that Indiana, the most manufacturing state in the country, enacted a right-to-work law in 2012.

It is surprising that Michigan has enacted a right-to-work law because from 2010-2012 it had the fourth highest union membership rate in the country behind Nevada, New York and Alaska.  Nevada is the right-to-work state with the highest union membership rate.  Nevada, Michigan and Indiana are the only right-to-work states with private sector union membership rates above the national average of 6.9%.  About 45% of total U.S. employment will now be in right-to-work states, where the average private sector union membership rate is 4.4%, less than half of the union membership rate of 8.9% in the other 26 states.

The following chart shows the uphill battle that private sector unions are likely to face at the ballot box in the years ahead.  Workers under the age of 35, who are becoming a more important force in elections, have not been members of private sector unions and therefore may be less likely to oppose right-to-work legislation.  Fewer than 3% of workers under the age of 35 in right-to-work states are union members.  Fewer than 6% of workers under 35 are union members even in states without right-to-work laws.


Given the age gap in union membership, it should not be surprising if right-to-work laws are considered by legislatures in other states.  Politicians in states competing for new businesses and jobs will continue to make the argument that jobs are being lost overseas and to states where unions are less of a force.  As long as job creation is a primary concern legislatures will consider laws that will weaken the strength of private sector unions.

The NBA Players’ Association Should Support Greg Popovich’s Decision to Rest Players

David Stern, commissioner of the NBA, fined the San Antonio Spurs $250,000 for resting four starting players, including stars Tim Duncan, Manu Ginobli and Tony Parker, in their game against the Heat in Miami on Thursday November 29.  The Spurs barely lost to the defending champion Heat in the closing minutes despite the fact that they played without four of their top players.  Coach Greg Popovich’s strategy may have worked, however, as the Spurs defeated the Memphis Grizzlies in overtime on Saturday night.  Memphis had the league’s best record entering the game.  Duncan, Ginobli, and Parker require more rest than many NBA stars because their ages are 36, 35 and 30, respectively.

Coach Popovich rested his top players because the Spurs were playing their third game in four nights and were in the midst of playing six games in nine days.  Teams playing three games in four nights tend to be fatigued and win fewer of the back-to-back games at the end of these sequences of games.  Most of the games played at the end of these sequences tend to be on the road, where the fatigued team is also the visiting team.  I analyzed NBA schedule data from the 2010-2011 season because the 2011-2012 season was strike-shortened and had a compressed schedule.  My analysis focused on away teams because of the small sample of home teams playing with such little rest in between games.  I found that NBA teams are significantly less likely to win a game when they are fatigued.

  • Visiting teams won 41% of NBA games when playing with at least one night’s rest (and not in the midst of three games in four nights).
  • Visiting teams won less than 29% of NBA games when playing back-to-back games at the end of a sequence of three games in four nights.

Playing games without much rest puts NBA teams at a disadvantage.  Rather than fining Greg Popovich for optimizing given the schedule the NBA has dictated to the Spurs, perhaps David Stern should be more concerned about scheduling equity.  Seven of 30 NBA teams (Cleveland, Golden State, Los Angeles Clippers, Milwaukee, Minnesota, New York and Washington) have to play three games in four nights on four different occasions this season.  Six teams (Boston, Dallas, Los Angeles Lakers, Memphis, Orlando and Utah) are scheduled to play three games in four nights at most once during the season.  The Spurs are scheduled to play three games in four nights on three occasions and therefore have one of the NBA’s least advantageous schedules in terms of opportunities for resting players.

It is not clear whether the Spurs will appeal Commissioner Stern’s fine.  If the Spurs appeal, the NBA Players’ Association should support their challenge.  First, resting players makes sense because it maximizes a team’s chance of success in a league where fewer than half of the teams are eliminated from the playoffs over the course of an 82 game schedule.  Second, resting players is likely to reduce the risk of serious injury.  As representatives of the players’ welfare, the NBA Players’ Association should be challenging the Commissioner’s decision.

Twinkies, Unions, Debt and Bankruptcy

Hostess is shuttering its bakeries and plants that produce Twinkies, Wonder Bread and other iconic snacks because of a strike, mismanagement and shifting preferences of the American consumer.  Pro-union advocates are blaming poor management and hedge funds.  Pro-management advocates are blaming unreasonable union demands.  Clearly neither side wanted the company to liquidate its assets.  Yet what happened to Hostess, and its workforce, is what we should expect from union-management battles in the U.S.  More than twenty years ago fellow Welch Consulting economist Donald Deere and I explained why management, faced with the threat of unionization and strikes, would use debt as a tool to protect its investors.

First, recognize that the valuable asset of union membership, unlike ownership of a company, is non-transferrable.  Upon retirement older union members can’t sell the property rights to their job in a unionized plant.  This means union members discount the future more than firm owners and shareholders.  The thousands of Hostess workers who retired in the past two decades were harmed less by the decline in the profitability of the company after their retirement than they would have if they could have sold their unionized jobs to the next generation of workers.  The right to work as a union member at a healthy company would sell for far more than the right to work for an unhealthy company.  (The absence of a market for the purchase and sale of union membership rights even though these rights yield a share of firm profits is an example of incomplete markets.)

Second, recognize that unions can bargain over the return on sunk investments (plant and equipment) and not just bargain over profits.  Once a billion dollar plant has been built, a union can hold-up management for the returns on that specific investment.  If the union succeeds, investors will get a lower return than they anticipated from their investment, but as long as variable costs are covered they won’t shut down the plant.  It is impossible for a union to pre-commit to only negotiating and striking for a share of the profits.  So even if a union has good intentions and promised only to negotiate for a share of profits, investors and management would be wary and assume the worst; the returns to sunk investments are assumed to be on the negotiating table.

What can firms do to protect investors from union demands?  They can use debt to make management threats more credible.  Investors and management facing the scenario described above will prefer debt finance to equity finance because debt makes the threat of bankruptcy more credible.  (Union threats are another reason why the Modigliani-Miller theorem doesn’t hold.)  The more debt-financed a company is, the more likely an adverse demand shift, bad management decisions or excessive labor costs will push the firm into bankruptcy.  Debtors must be paid whereas union demands come before dividend payments to shareholders.  So companies like Hostess use debt-finance as leverage against unions, knowing that this allows them to get more wage and benefit concessions from unions.  Unions are constrained more if a company threatens to file for bankruptcy because it can’t pay its debts than if the company threatened to suspended dividend payments to its shareholders.

The high debt to equity policy for management is similar to the sequestration policy agreed to by the President and the Congress.  At the time the sequestration deal was made, neither branch of government wanted to go over the fiscal cliff.  The deal’s purpose was to constrain the negotiations of the parties going forward.  Likewise, the owners of Hostess did not want their negotiations to end in the liquidation of the company.  They put in place a mechanism designed to limit future union wage demands even though they knew it would increase bankruptcy risk.  They likely made such a choice in order to protect their profits and the return on their sunk investments.  The lesson is that poison pills designed to constrain bargaining positions will sometimes have to be swallowed.

Fiscal Restraint and Casimir Pulaski Day

There has been considerable discussion this election year about the economic consequences of fiscal restraint.  Some economists believe that the economic recovery has been hampered by government cutbacks in particular spending programs.  A recent article in the Wall Street Journal noted that as state and local governments “get a handle on their finances” its “good news for tomorrow’s economy” but “straining today’s recovery.”

Downsizing institutions, public or private, is costly because it takes time for resources to be reallocated to other sectors of the economy.  However, wasteful government spending diverts resources from other more valuable uses and does not stimulate the economy.  There is no sensible economic argument, even in a weak economy, for delaying cuts in duplicative, ineffective or wasteful government programs.

President Obama’s jobs bill includes $35 billion of Federal aid for state and local governments to be used for teachers, police and firefighters.  Voters seem more likely to support this policy because they see the tangible benefits from this focused spending.  However, the President’s  support will dwindle if the pay and benefits of government workers seem excessive for the typical voter.  For example, a recent story in the Chicago Sun Times indicated that the average pay for a unionized Chicago firefighter is about $104,000 per year while the average full-time worker in Chicago earns $49,000 per year (according to the Bureau of Labor Statistics).

Chicago firefighters receive costly collectively bargained perks and retirement and health care benefits.  For example, firefighters in Chicago are awarded thirteen paid holidays and receive double time if they work on any holiday including Flag Day, both Lincoln’s and Washington’s birthdays, and Casimir Pulaski Day (March 4).  Democratic mayor Rahm Emmanuel is currently negotiating for limits on non-wage benefits in a new contract with the firefighters’ union (whose current five-year agreement ends in a few days).  Emmanuel is at the bargaining table with the same union leaders who helped elect him.  He knows that support for President Obama’s $35 billion spending package for teachers, police and firefighters will evaporate if voters believe that this money is not being spent wisely.

There are a number of areas where there is some bi-partisan support for government spending reductions.  The GAO recently released a report detailing $100 billion in possible savings by eliminating duplicative programs.  Senators Tom Coburn (R-OK) and Mark Udall (D-Co) and Representatives from both parties introduced legislation to eliminate duplicative government programs.  These cuts in spending will help the economy, even in the short run, and free up resources for more valuable projects.

Even wasteful government spending is difficult to eliminate because of vested interest in the status quo and the political power of government unions and contractors.  Al Gore, Jr. tried to reinvent government and Bill Clinton said the era of big government is over.  But, Ronald Reagan knew how difficult it is to achieve fiscal restraint.  He said: “No government ever voluntarily reduces itself in size.  Government programs, once launched, never disappear.  Actually, a government bureau is the nearest thing to eternal life we’ll ever see on this earth!”

Dyed-in-the-wool Keynesians believe all government spending stimulates the economy, even a holiday honoring Casimir Pulaski or an expensive junket to Las Vegas for GSA employees.  Keynesian economists who advocate government spending for its own sake are their own worst enemies.  Taxpayers will lose confidence in government solutions to economic problems if fiscal restraint is dismissed even as journalists report on government spending excesses.

Should President Obama Suspend the Davis Bacon Act?

Professor Robert Frank argues for more government spending on infrastructure in an opinion piece in the New York Times.  Frank writes that both Mitt Romney and President Obama should be “willing to take the one politically feasible step that could help mend the economy quickly: an accelerated program of infrastructure repairs.”  Frank’s column is quite similar to one written in October 2011 by informal Obama advisor Richard Thaler, who wrote that infrastructure investments are “on sale” because of low interest rates.  Frank seconds this argument by writing “many skilled people who can do these jobs are unemployed today. If we wait, we’ll have to bid them away from other useful work. And with much of the world still in a downturn, the required materials are cheap.”

The problem, as I noted in an earlier blog post, is that labor costs for government construction projects are dictated by the Davis Bacon Act and not by competitive labor market conditions.  The Davis Bacon Act states:

every contract in excess of $2,000, to which the Federal Government or the District of Columbia is a party, for construction, alteration, or repair, including painting and decorating, of public buildings and public works … and which requires or involves the employment of mechanics or laborers shall contain a provision stating the minimum wages to be paid various classes of laborers and mechanics.

minimum wages shall be based on the wages the Secretary of Labor determines to be prevailing for the corresponding classes of laborers and mechanics employed on projects of a character similar to the contract work in the civil subdivision of the State in which the work is to be performed . . .

The prevailing wages set by the Secretary of Labor are generally substantially higher than the median wage in BLS surveys, even in areas where the construction industry has been decimated by the recession.  The following chart shows the change in construction employment in four counties especially hard hit by the recession.

One would expect that construction workers would be willing and able to work on infrastructure projects for relatively low rates of pay in these counties.  In Clark County, Nevada, for example. construction employment fell by more than one half.  Unfortunately the prevailing wages set by the Secretary of Labor for heavy construction projects in Clark County do not reflect the slack in the labor market:

  • Flagperson                                                      $41.44 per hour
  • Carpenter                                                        $45.11 per hour
  • Structural Ironworker                                   $56.74 per hour
  • Crane Operator                                               $66.75 per hour

These hourly wages are, on average, about 12.8% higher than they were in 2007 when the construction sector in Las Vegas and Clark County was booming.  The prevailing wages in Riverside, Maricopa and Miami-Dade counties are similarly high and have also increased over the past few years even though the demand for construction labor has plummeted.

Government infrastructure projects are expensive because prevailing wages are above the market wages measured by the Bureau of Labor Statistics.  High labor costs make infrastructure projects much less of a bargain than Professors Thaler and Frank have argued.

What can President Obama do? He can suspend the Davis Bacon Act until the economy, especially the housing market and construction sector, has recovered.  Suspension of the Davis Bacon Act is not without precedent in the case of a national emergency.  President George W. Bush suspended Davis-Bacon in Alabama, Florida, Louisiana and Mississippi in the fall of 2005 as the region recovered from Hurricane Katrina.

Mr. President, we face an emergency in the construction sector.  Housing prices have not recovered from the recession and employment in the construction sector is far below its pre-recession levels.  Professors Frank and Thaler are correct – it makes sense to invest in infrastructure projects when they are “on sale.”  The Davis Bacon Act stands in the way of getting important construction projects completed at a reasonable cost to taxpayers.  In addition, a bold move like suspending Davis Bacon could encourage Republicans in Congress to support other job initiatives that you favor.

NBA Players Can’t Shoot Straight after the Lockout

All the excitement generated by Jeremy Lin seems to have distracted fans from what’s really happening this NBA season.  Charles Barkley is paying attention, and he said “As a NBA fan, I want to apologize to the fans.  I cannot believe how bad the NBA is right now.” Offenses are performing poorly this season and there is a simple explanation, the lockout that delayed the start of the season and all but eliminated team practices.

This is the second NBA lockout serious enough to result in limited training camps and a shortened regular season; in 1999 the NBA played a 50-game schedule.  NBA lockouts reduce shooting accuracy and these negative effects may persist for several seasons.  Basketball productivity probably declined because pre-season practices, mid-season practices and rests days were curtailed in order to fit 66 games between Christmas and late April.

The following figure illustrates the average effective shooting percentage in NBA regular seasons from 1980, when the 3 point shot was introduced, to the current season (so fare).  The effective shooting percentage is a weighted average of 2 point and 3 point shooting percentages, where each 3 point shot receives one and a half the weight of a 2 point shot.  The figure indicates that although shooting accuracy varies from year to year, it dropped shortly after both work stoppages, and remained lower for several seasons after the 1999 lockout.

I estimated a simple regression that allows for differences in shooting accuracy among teams and correlation in the fluctuations in a team’s shooting percentage from one year to the next.  The regression model suggests that lockouts cause a 1.5% decline in the effective shooting percentage in the first season after a lockout.  The model also predicts that shooting percentages will remain lower because of the time series correlation in shooting accuracy.

The statistical model can be used to predict how the most recent lockout will reduce NBA scoring over the next few seasons.   Combined scoring by both teams is expected to drop by 5.5 points in 2012 and 3.3 points in 2013 due to the reduction in shooting accuracy.

NBA coaches and teams can adjust strategies to mitigate the impact of the prolonged lockout.  For example teams can attempt more (or fewer) 3 point shots and slow down (or speed up) the pace of play.  If these adjustments are made scoring reductions could be somewhat smaller than the model’s predictions.

Some fans believe that the NBA’s 82-game regular season is too long, so that a silver lining of the 2011 lockout is a shortened 66-game schedule.  Whether or not the regular season is too long, compressing a 66 game season into four months has a negative impact on offensive efficiency.  Practices and rest days are important, even for the world’s best athletes competing at the highest level.  The elimination of rest days and practices appears to be relatively more important for basketball offenses.

Vanishing Private Sector Unions

Yesterday Indiana Governor Mitch Daniels signed the law making Indiana the only right-to-work state in the Rust Belt.  Earlier this week pollster Scott Rasmussen reported that 74% of voters favor right-to-work laws that would eliminate mandatory dues and make it much more difficult for unions to organize.  Public employee unions are also being challenged.  In November Ohio voters rejected a law that restricted the collective bargaining rights of public sector unions, and Wisconsin Governor Scott Walker is facing a possible recall after signing a similar bill in Wisconsin.

Voters’ sentiments seem to reflect their labor market experiences.   Private sector unions are vanishing, which will erode support for laws and regulations that strengthen or preserve their bargaining power.  On the other hand membership has never been higher in public sector unions.  I expect well-organized opposition to bills such as the one introduced in Arizona, which limits the collective bargaining power of public sector unions.

The latest Labor Department data indicate that union members comprise only 6.9% of the private sector workforce.  Private sector union membership rates peaked in the 1940s and 1950s at about 1/3 of the workforce.  Unions were virtually nonexistent until the 1960s.  Today the situation has reversed and there are more union members in government than in the private sector.

Union members are older than non-union workers.  In the private sector there are about the same number of non-union workers under the age of 30 and age 55 and above.  Among union members there are 2.5 workers age 55 and above for each worker under 30.  The following figure illustrates private sector union membership rates for four different age cohorts.  The only age group that ever experienced membership rates in excess of 20% includes workers who are now age 55 and above.  Younger age cohorts have seen stable membership rates of 10% or less.  If these trends continue no more than 5% of the Millennial Generation will ever be (private sector) union members.

The aging of the private sector union workforce means that the issues that matter to Richard Trumka, and the AFL-CIO, are unlikely to energize younger voters.  Voters who never belonged to a union show little interest in recess appointments to the National Labor Relations Board, NLRB rules changes that give unions an organizing advantage, the NLRB’s opposition to Boeing’s plans to shift production from Washington to South Carolina, or Indiana’s right-to-work law.  In an earlier era when the AFL-CIO had more political clout, these issues would have been pivotal in an election year.

Local government employees, such as teachers, sanitation workers, police and firemen, have the highest union membership rates that we have ever seen in any sector of the economy in U.S. history (43%).  The battleground for the labor movement has shifted to laws that limit the collective bargaining rights of unions representing government workers, as in Arizona, Ohio and Wisconsin.  These laws have gained support as local governments have been squeezed by declining property values and tax bases and increasing costs of health care benefits and pensions.  The result of the efforts to recall Governor Scott Walker will foreshadow whether public sector unions can maintain their bargaining power and political clout.

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