1 The Economics of Unions Giorgio Brunello

2 Unions cross-country (Visser, 2006, Mon Lab Rev) 2 things to note: 1. Large cross-country variation in prevalence of unions 2. Apart from Belgium – decline in all countries

Why has Union Membership Declined? The structure of the labor market has been changing since the 1960s – more services jobs, fewer manufacturing jobs Globalization bad for unions Blue collar workers are less prevalent There has been a marked increase in labor force participation rates of women Workers’ demand for union jobs has declined Firms have become more resistant to unions

Monopoly Unions: the baseline model A union that is a sole seller of labor Wages W and employment N Monopoly on supply implies that the union sets the wage Employment is set by the firm Sequential game: – Union sets W knowing that firm sets N – Firm sets N to max profits

The Firm We solve by backward induction The firm is a price and wage taker and chooses employment to maximize profit Labour demand

The Union How do we define union preferences? Difficult, because unions are complex organizations A nice shortcut is to say that unions prefer higher wages and higher employment The union utility function

7 Union Preferences Wages Employment U 2 >U 1 >U 0 U2U2 U0U0 U1U1

Solving the sequential game

The Behavior of Monopoly Unions Dollars Employment EMEM E*E* w*w* wMwM D U U D M M A monopoly union maximizes utility by choosing the point on the demand curve D that is tangent to the union’s indifference curve. The union demands a wage of w M dollars and the employer cuts back employment to E M (from the competitive level w * ). If the demand curve were inelastic (as in D ), the union could demand a higher wage and get more utility.

Ex-ante and ex-post Ex-ante, expected utility of union member is Ex-post, some union members are employed at a higher wage and some are unemployed

Elasticity of Demand for Union Labor Availability of substitute products: unions would attempt to reduce the availability of substitutes for the products they produce, through such means as import restrictions. Availability of substitute factors: two general substitutes for union labor: nonunion labor and certain types of machines; unions would attempt to reduce the availability of nonunion labor and nonhuman workers by opposing relaxation of immigration laws, supporting a high minimum wage, and opposing automation as substitute for labor.

For union A, which has an inelastic demand for its labor between W 1 and W 2, a higher wage rate brings about a smaller cutback in the quantity of labor than for union B, which has an elastic demand for its labor between W 1 and W 2. We predict that union B will be less likely to push for higher wages than union A because of its wage- employment tradeoff is more pronounced.

Unions and Market Efficiency In the absence of unions, the competitive wage is w* and national income is given by the sum of the areas ABCD and ABCD. Unions increase the wage in sector 1 to wU. The displaced workers move to sector 2, lowering the nonunion wage to wN. National income is now given by the sum of areas AEGD and AFGD. The misallocation of labor reduces national income by the area of the triangle EBF.

Do unions really control wages? Most likely they bargain over wages with firms Bargaining as a sequential game (ex: the game of chess) The game would last forever if players are patient enough and the size of the cake does not shrink But production losses during negotiation as well as impatience leads to an agreement in finite time Strikes may occur during the bargain

Nash bargaining Axiomatic approach (the outcome must satisfy some axioms) that converges to solution of sequential game Nash maximand with a single worker

Solution w N Wm Wb Wc Monopoly union Nash bargaining Perfect competition

“Efficient” Contracts The firm and the union could make a deal that makes at least one of them better off without making the other worse off The efficient contract curve lies to the right of the labor demand curve Efficient contracts imply that unions and employers bargain over wages and employment

Isoprofit curves

19 Isoprofits Wages Employment L* D Profit = £ Profit = £250000

Efficient Contracts and the Contract Curve U*U* UMUM URUR UZUZ w*w* E*E* wZwZ EZEZ wMwM P Q R Z Employment Dollars M ** MM ZZ At the competitive wage w *, the employer hires E * workers. A monopoly union moves the firm to point M, demanding a wage of w M. Both the union and firm are better off by moving off the demand curve. At point R, the union is better off, and the firm is no worse off than at point M. At point Q, the employer is better off, but the union is no worse off. If all bargaining opportunities between the two parties are exhausted, the union and firm agree to a wage-employment combination on the contract curve PZ.

Efficiency more formally

Why efficient? In a Pareto sense: the allocation is such that there are no deviations from the allocation such that – Union is better off and firm is not worse off – Firm is better off and union is not worse off Nice, but how plausible that unions bargain over employment? (can unions control employment?) Are efficient contracts sustainable equilibria?

Strongly Efficient Contracts The contract curve is vertical Employment is equal to the competitive level but wages tend to be higher

Strongly Efficient Contracts: A Vertical Contract Curve U*U* UMUM URUR UZUZ w*w* E*E* wZwZ EZEZ wMwM P Q R Z Employment Dollars M ** MM ZZ If the contract curve PZ is vertical, the firm hires the same number of workers that it would have hired in the absence of a union. The union and firm are then splitting a fixed-size pie as they move up and down the contract curve. At point P, the employer keeps all the rents; at point Z, the union gets all the rents. A contract on a vertical contract curve is called a strongly efficient contract.