The Economic Impact of Unions Chapter 11 The Economic Impact of Unions McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

1. The Union Wage Advantage 6/4/2018 1. The Union Wage Advantage 11-2

Preliminary Complications 6/4/2018 If unions raise wages for a firm in a perfectly competitive market, the firm will not survive due to their higher costs. Unions try to organize all of the firms in an industry to prevent unionized firms being at a cost disadvantage. Simply comparing wages in highly unionized industries with those in less unionized industries may be misleading. Factors other than unions may explain the difference – plant size, worker skills, etc. 11-3

6/4/2018 Union Wage Advantage If we could compare wage rates in a given labor market, where all conditions were held constant except for the presence of the unions, we could calculate a pure measure of the union’s wage advantage. Quantity of Labor Hours Wage rate S D Q1 Wn Q2 Wu The pure wage advantage is (Wu-Wn)/ Wn * 100. Unions may influence the wage rates of nonunion workers as well as the wage rates of their own workers in the real world. 11-4

Spillover and Threat Effects 6/4/2018 The spillover effect suggests that as a union is able to raise wage rates from Wn to Wu, employment in the union sector will fall by Q2 - Q1. Quantity of Labor Wage rate Du Q2 Wu Q1 Wn Union Dn Quantity of Labor Wage rate Q1 Wn Nonunion Q2 Ws The reemployment of these workers in the nonunion sector, will reduce wages from Wn to Ws, which means the measured wage advantage [(Wu-Ws)/ Ws] overstates the pure wage advantage. Q3 Wt The threat effect is that nonunion employers raise wages from say Wn to Wt to prevent unionization. The threat effect causes the measured wage advantage [(Wu-Wt)/Wt] to understate the pure wage advantage. 11-5

Product Market Effect Wage rate 6/4/2018 Product Market Effect Quantity of Labor Hours Wage rate S D1 Q1 Wn An increase in union wages will raise costs and prices in the union sector. D2 Q2 Wp As a result, the demand for nonunion product and thus raise the demand for nonunion labor (D1 to D2). This will tend to raise wages in the nonunion sector and thus the measured union wage advantage will understate the pure wage advantage. 11-6

Other Effects on Nonunion Wages 6/4/2018 Other Effects on Nonunion Wages Wait unemployment Some of the workers who become unemployed when union increases the wage rate in the union sector may prefer to wait for a job in the union sector rather than take a job in the nonunion sector. This reduces the spillover effect and its resulting overstating of the pure wage advantage. 11-7

Other Effects on Nonunion Wages 6/4/2018 Other Effects on Nonunion Wages Superior-worker effect The higher wages at union firms will allow them to hire better workers. This causes the measured wage advantage to overstate the pure wage advantage. 11-8

6/4/2018 Union Wage Advantage The union wage advantage rose in the late 1970s as union wages were protected from inflation with cost of living adjustments, but nonunion wages were not. The union wage advantage was relatively stable in the low twenties from the mid 1980s to the mid 1990s. The union wage advantage has fallen from 23 in 1994 to about 15 percent now. 11-9

Variations in Union Wage Advantage 6/4/2018 Variations in Union Wage Advantage The union wage advantage is greater for the following: Recessions Construction workers Black males Blue-collar workers Less-educated workers 11-10

6/4/2018 Total Compensation Total compensation is the sum of wages and fringe benefits. Union workers have more fringe benefits than nonunion workers because: Union workers have higher wages and want to “buy” more fringe benefits. Union workers are older. Unions are able to express worker’s preferences for more fringe benefits. Union workers have greater job tenure and thus are more likely to collect a pension. 11-11

6/4/2018 Question for Thought 1. How is the “pure” union wage advantage defined? If in a given labor market the wage rate would be $8 without a union and $10 with a union, then what is the pure union wage advantage? Explain how, and in what direction, each pf the following might cause the “measured” wage advantage to vary from the pure wage advantage: (a) the spillover effect, (b) the threat effect, (c) the product market effect, (d) the wait unemployment effect, and (e) the superior worker effect. 11-12

2. Efficiency and Productivity 6/4/2018 2. Efficiency and Productivity 11-13

Negative Effects Restrictive work rules 6/4/2018 Negative Effects Restrictive work rules Unions may impose work rules that decrease efficiency or productivity. Limits on output Time consuming production methods Requiring unnecessary work to be done Requiring unnecessary workers to be hired Restrict the types of work that a worker can perform These work practices also exist in the nonunion sector. 11-14

Negative Effects Strikes 6/4/2018 Negative Effects Strikes Strikes are relatively rare and account for < .1% of total estimated total working time. Data on working time may overstate the output loss due to strikes since firms may build up inventories in anticipation of a strike. Data on working time may understate output loss due to strikes since the strike may disrupt production in other industries. The effects on non-striking firms are likely to be greater when services are involved. 11-15

Strikes The number of work days lost has trended downward since 1970. 6/4/2018 Strikes The number of work days lost has trended downward since 1970. 94% of the lost work days in 2000 were the result of 4 strikes. 11-16

Negative Effects Wage advantage and labor misallocation 6/4/2018 Negative Effects Wage advantage and labor misallocation The higher wage in the union sector causes workers to be displaced to the nonunion sector. This causes an efficiency loss because the loss in output in the union sector is greater than the gain in the nonunion sector. The value of marginal product of the laid off is greater in the union sector than in the nonunion sector. 11-17

Negative Effects Wage advantage and labor misallocation Qualifications 6/4/2018 Negative Effects Wage advantage and labor misallocation Qualifications Unemployment If the workers laid off are not reemployed in the nonunion sector, the efficiency loss is larger. Job search costs If there are search costs with finding reemployment, then efficiency loss will be larger. 11-18

Negative Effects Empirical evidence 6/4/2018 Negative Effects Investment behavior and productivity growth The misallocation of labor described earlier is a static or short-run efficiency loss. There may also be a dynamic or long-run efficiency loss. If unions are able to extract a large part of the returns to capital, then firms will be less likely to invest in capital and reduce productivity growth. Empirical evidence Unions have a small static efficiency loss on output. 11-19

Positive Effects Investment and technological progress 6/4/2018 Positive Effects Investment and technological progress The higher union wages may cause firms to invest in capital in order to substitute for the relatively more expensive labor. Unions as a collective voice Unions function as collective voice for their members to resolve disputes, improve working conditions, etc. Workers morale increases and so does productivity. 11-20

Positive Effects 6/4/2018 Union workers have lower turnover due to collective voice effect as well as the union wage advantage. Union workers have higher productivity due to their greater worker experience. Union firms are more willing invest in training. Due to seniority layoff, senior union workers are more willing to provide informal training to less senior workers. 11-21

Positive Effects Empirical evidence 6/4/2018 Faced with a higher union wages, firms may have a shock effect on productivity. Managers try to increase efficiency in order to offset effect of higher union wages. Empirical evidence The empirical evidence regarding the impact of unions on productivity is mixed. 11-22

6/4/2018 3. Firm Profitability 11-23

Firm Profitability Nearly all studies find that unions reduce profits. 6/4/2018 Firm Profitability Nearly all studies find that unions reduce profits. If unions reduce profits in monopolistic industries, then no efficiency loss occurs. If unions reduce profits in competitive industries, then an efficiency loss occurs since firms will leave the industry. Output will be lower and prices higher. The empirical evidence is mixed on whether there is an efficiency loss. 11-24

4. Distribution of Earnings 6/4/2018 4. Distribution of Earnings 11-25

Increasing Inequality 6/4/2018 Increasing Inequality Unions increase income inequality in three ways: Increasing the wages of union workers and lowering the wages of nonunion workers through the spillover effect. Increasing the wages of skilled blue-collar workers relative to unskilled blue-collar workers. Increasing the demand for skilled labor within unionized firms. 11-26

Decreasing Inequality 6/4/2018 Decreasing Inequality Unions decrease income inequality in three ways: Equalizing wages within firms. Unions try to make pay tied to jobs and not individual workers. Unions seek a wage policy of equal absolute dollar wage increases for workers. Equalizing wages across firms Unions seek to standard wage rates among firms. This enables unions to protect their wage advantage. 11-27

Decreasing Inequality 6/4/2018 Decreasing Inequality Reducing the white-collar to blue-collar differential. The empirical evidence is that unions reduce income inequality on net. 11-28

5. Other Issues: Inflation, Unemployment, and Income Shares 6/4/2018 5. Other Issues: Inflation, Unemployment, and Income Shares 11-29

Other Effects Inflation Unions and unemployment 6/4/2018 Other Effects Inflation Unions are not a cause of inflation like monetary policy. Unions and unemployment Unions may reduce downward wage flexibility and thus increase unemployment. Reduce worker turnover and thus unemployment. High union wage rates may increase unemployment by attracting new entrants. The evidence is unions have only a small effect on unemployment. 11-30

Other Effects Labor’s share 6/4/2018 Other Effects Labor’s share Unions have not been able to increase the share of income going to labor rather than capital. The higher union wages come at the expense of lower wages for nonunion workers. Union wage increases may cause firms to substitute capital for labor. Firms may avoid an impact on capital income through productivity and price increases. 11-31

Questions for Thought 1. Comment on each of the following statements: 6/4/2018 Questions for Thought 1. Comment on each of the following statements: (a) “Unions tie the hands of management and inhibit efficient decision making.” (b) “Unions contribute to economic efficiency in that union wage pressure hastens the weeding out of the high-cost, least-efficient producers in each industry.” (c) “Although unions may reduce wage inequality, to the extent they reduce wage differentials based on individual merit and effort, the outcome may be rightly perceived as both inequitable and inefficient.” (d) “Unions impair the efficiency of our economy indirectly by diminishing profits and thereby reducing investment and economic expansion.” 11-32