The Theory of Trade Unions: A Brief Introduction

Background

• suppose labour markets are competitive i.e. each employer thinks they can hire as many workers as they want at the going market wage, B

• the wage paid will be equal to B - there is no point in paying a higher wage and a lower wage results in no workers being hired.

• the firm will choose the level of employment to maximize profits which leads to MRPL=B:

'R N B

In a picture…

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Log

Wag

e

0 1 2 3 4log employment

log MRPL log competitive wage

What happens to wages/employment if there is a union?

• need to make some assumptions about:– the preferences of the union– the process of bargaining between employer

and union.

The preferences of unions

• large literature debating what the objective function of a union is likely to be.

• But good reason to think unions like: – higher wages (unions do set out to raise

wages for their members)– higher employment (they normally fight

reductions in employment).

• A simple way of capturing these ideas is to assume that the utility function has the form: U N W B

So indifference curves look like..

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Log

Wag

e

0 1 2 3 4log employment

log MRPL log competitive wageunion indifference curve

The Process of Bargaining

• Two main issues:– the subject of bargaining– whose preferences, employer or union, get most weight in

determining the outcome.

• On the subject of bargaining, there are two main models:• the labour demand curve (or right-to-manage) model

– unions and employer negotiate the wage but employment is determined unilaterally by the employer.

• the efficient bargain model– unions and employer negotiate both the wage and employment.

The Labour Demand Curve Model

• Given wage, employment will be where MRPL=w

• But what will be the wage?

• Consider extreme case where union has all the bargaining power

• Will choose point on labour demand curve that gives highest utility

Graphically…

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1.5

Log

Wag

e

0 1 2 3 4log employment

log MRPL log competitive wageunion indifference curve

What determines how high this wage will be?

• One can show that the wage will be lower:– the more sensitive is labour demand to the

wage (the higher the wage elasticity of labour demand) – a high elasticity makes the trade-off between wages and employment less attractive.

– the more the union cares about employment relative to the wage.

Between the extremes..

• What happens if we have some distribution of bargaining power between union and employer between the two extremes we have discussed?

• It should not be hard to see that we will have some outcome on the labour demand curve between the two extremes and that the wage will be lower:– the more bargaining power the employer has

In the labour demand curve model..

• Unions raise wages

• Unions reduce employment

• Unions reduce profits

• In a model with capital they would also reduce investment

• But perhaps this is not the final word

The Efficient Bargain Model

• The labor demand curve model is based on a ‘realistic’ set of assumptions.

• The criticism is that the outcome has unexploited gains from trade.

• To see this consider drawing iso-profit curves on Figures. The have an inverted u-shape and, more importantly, they are horizontal at all points on the labour demand curve.

Implication

• at the monopoly union outcome, the firm iso-profit curves and union indifference curves are not tangential

• both parties could be made better-off by swapping a reduction in the wage for some increase in employment away from the labor demand curve.

• The efficient bargain model makes both wages and employment the subject of bargaining

• leads to an outcome in which all gains from trade are exploited and union indifference curves and firm iso-profit curves are tangential.

• there are many such points differing in the distribution of surplus between employer and union – the set of these points is called the contract curve.

The Contract Curve

• Can show that contract curve has the form

• If γ=0 then same as labour demand curve• If 1>γ>0 then downward-sloping• If γ=1, then vertical• If γ>1, upward-sloping• Unions raise wages but may also raise

employment (depending on preferences)

Empirical Evidence: Wages

• very large literature on the effect of unions on wages (the union wage mark-up).

• Typically this includes union status in an earnings function together with other factors and interprets the coefficient on the union variable as the causal effect of union status on wages.

• Little experimental or quasi-experimental evidence but people accept this literature as it gives ‘sensible’ answers – a mark-up of 15+% in the US, 10% in the UK (though zero in recent years).

Empirical Evidence: Employment

• The literature on the impact of unions on employment is tiny.

• In part this is because the equivalent of the above wage regression – regress employment on union status leads to a strong positive effect, something people have been very reluctant to believe.

• Perhaps for good reason, as unions may be more likely to succeed in organizing workers in large firms.

diNardo-Lee

• Contribution needs to be set against weaknesses of other literature

• They exploit the fact that unions in the US have to win a representation election to be allowed to negotiate.

• This leads to a RDD design in which one can compare subsequent outcomes in firms where the union just won with the outcome in firms where the union just lost.

• There is a good discussion in the paper of what one can hope to estimate using this – the ‘impact of unionization’ is too simple. They summarize what one might expect in:

Conclusion

• union impact on the ‘bottom line’ is very small on:– business survival– Employment– Output– Productivity– wages

• i.e. unions seem to do very little. A representative type of empirical finding is:

The Effect on Employment

A puzzle

• Even the effect on wages is very small compared to previous estimates.

• How can we interpret these results and reconcile them with other findings:– studies ‘young’ unions who have less impact – but wage effect

on cross-section is similar to other studies.– can only identify effect at margin but not much evidence of other

effects.

• Its all a bit troubling – this study has the best quality data but conclusions that are at odds with – what many people think– the fact that employers spend large sums of money trying to

avoid unions.

Conclusion

• Hard to get good research design to study the effect of unions

• Best study we has fails to find any effects at all

• But reluctant perhaps to believe that

• Research does not always give us clear answers