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Chapter 11: The Economic Impact of Unions

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1. The Union Wage Advantage

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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.

Preliminary Complications

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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’swage advantage.

• The pure wage advantage is (Wu-Wn)/ Wn * 100.

Quantity of Labor Hours

Wage rateS

D

Q1

Wn

Q2

Wu

• Unions may influence the wage rates of nonunion workers as

well as the wage rates of their own workers in the real world.

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• 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.• 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.• The threat effect is that nonunion employers raise wages from say Wn to Wt to

prevent unionization.

Quantity of Labor

Wag

e ra

te

Du

Q2

Wu

Q1

Wn

Union

Spillover and Threat Effects

Q3

Wt

Dn

Quantity of Labor

Wag

e ra

teQ1

Wn

Nonunion

Q2

Ws

• The threat effect causes the measured wage advantage [(Wu-Wt)/Wt] to understate the pure wage advantage.

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Product Market Effect• An increase in union wages will

raise costs and prices in the union sector.

• 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.

Quantity of Labor Hours

Wage rateS

D1

Q1

Wn

D2

Q2

Wp

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Wait unemployment Some of the workers who become

unemployed when union increase 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.

Other Effects on Nonunion Wages

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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.

Other Effects on Nonunion Wages

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Union Wage Advantage

0

5

10

15

20

25

1973 1977 1981 1985 1989 1993 1997

Per

cent

Uni

on W

age

Dif

fere

ntia

l

• 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 high teens from the mid 1980s to the mid 1990s.

• The union wage advantage has fallen from the high teens in 1994 to 15 percent now.

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The union wage advantage is greater for the following: Recessions Construction workers Black males Blue-collar workers Less-educated workers

Variations in Union Wage Advantage

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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.

Total Compensation

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Questions 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 (ed) the superior worker effect.

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2. Efficiency and Productivity

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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.

Negative Effects

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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.

Negative Effects

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Strikes

0

10

20

30

40

50

60

1960 1968 1976 1984 1992 2000

Mil

lion

s of

wor

k da

ys lo

st• 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.

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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.

Negative Effects

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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.

Bilateral monopoly• If unions are bargaining with a monopsonist, then

the efficiency loss may be smaller.

Negative Effects

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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

Negative Effects

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Investment and technological progress The higher union wages may cause firms

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

Positive Effects

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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.

Positive Effects

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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.

Positive Effects

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3. Firm Profitability

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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.

Firm Profitablity

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4. Distribution of Earnings

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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.

Increasing Inequality

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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.

Decreasing Inequality

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Reducing the white-collar to blue-collar differential.

The empirical evidence is that unions reduce income inequality on net.

Decreasing Inequality

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5. Other Issues: Inflation, Unemployment, and

Income Shares

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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.

Other Effects

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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.

Other Effects

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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.”

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EndChapter 11