Unit 2 Unemployment, wages, and inequality: Supply-side policies and institutions

2.5 Labour unions

trade union, labour union

A trade union, or labour union, is a membership organization of workers. Its principal activities are the negotiation with employers of rates of pay and conditions of employment for its members.

The WS–PS model of the aggregate economy developed in Unit 1 is about firms and individual workers. But, in many countries, labour unions play a big part in how the labour market works. A trade union⁠trade union, labour union A trade union, or labour union, is a membership organization of workers. Its principal activities are the negotiation with employers of rates of pay and conditions of employment for its members.close or, equivalently, a labour union, is an organization that can represent the interests of a group of workers in negotiations with employers over issues such as pay, working conditions, and working hours. The resulting contract is between the firm or organization representing employers and the labour union. As shown in Figure 2.13, the fraction of the workforce employed under collective bargaining agreements negotiated by labour unions varies greatly between countries, from virtually all workers in Italy and some northern European economies, to hardly any in the US and South Korea.

Labour unions, the threat of going on strike, and the bargained wage-setting curve

Where workers are organized into trade unions, the wage is not set by the HR department but instead is determined through a process of negotiation between a union representing workers and the firm’s HR department. Although the wage must always be at least as high as the wage indicated by the aggregate wage-setting curve for the given level of unemployment, the bargained wage can be above the wage-setting curve.

The reason is that the employer’s threat to dismiss the worker is now not the only exercise of power that is possible. The union can threaten to ‘dismiss’ the employer (at least temporarily) by going on strike, that is, withdrawing the employees’ labour from the firm.

Therefore, the firm must agree to a wage that ensures that it will have the required work done to produce the goods or services on which its profits depend. This requires both that:

• The workers will provide sufficient effort when they come to work: The wage-setting curve determines this.
• The workers will come to work rather than go on strike: A bargained wage-setting curve will determine this.

We can think of a ‘bargaining curve’ lying above the wage-setting curve, which indicates the wage that the union–employer bargaining process will produce for every level of employment.

The relative bargaining power of the union and the employer determines how far this bargaining curve lies above the wage-setting curve. The union’s power depends on the ability to withhold labour from the firm, so its bargaining strength will be greater if it can ensure that during a strike, no other workers will offer their services to the firm.

This and the other determinants of bargaining power depend on the laws and social norms in force in an economy. In many countries, for example, it is a serious violation of a social norm among workers to accept a job offer in a firm whose workers are on strike.

Figure 2.14 shows that the bargained wage-setting curve lies above the WS curve. In the equilibrium where the bargained wage-setting curve intersects with the PS curve, the wage is unaffected, but the level of employment is lower.

We can summarize the impact of union wage-setting behaviour in this model:

• The short-run impact shifts the wage-setting curve upwards: Assuming all workers are covered by the higher union wage, the employed receive higher wages (point C).
• The long-run impact is higher structural unemployment and an unchanged wage for the employed: There is a new Nash equilibrium in the long run. The economy is at point E′. The unintended consequences are that fewer workers are employed and the wage is no higher than in the absence of the union.

Unions in the model and in the data

Paradoxically, it seems from the model that the union’s success in bargaining would harm workers, since the real wage is unchanged and more people are out of work. But from the data on union bargaining coverage and unemployment (Figure 2.15), unemployment does not seem to be higher in countries where union bargains are important in wage-setting.

Austria, with almost all employees covered by union wage bargains, has a lower unemployment rate (averaged over 2000–2020) than the US, where fewer than one in five workers is covered by union contracts. Spain and Poland both had massive unemployment over this period, but union coverage was very high in Spain and very low in Poland.

Therefore, the fact that unions can push the wage-setting curve upwards to the new WS (union) curve cannot be the entire story.

A powerful union may choose restraint

One possible explanation is that a powerful union may choose not to raise the wage, even if it has the power to do so. This is because even a very powerful union can only set the wage: it cannot determine prices (and therefore the real wage) or how many people the firm hires.

Unions may choose to restrain their use of bargaining power. If their wage setting covers a substantial part of the economy, they will take into account the effect of their wage decision on the wages and employment of workers in the economy as a whole. The union negotiators may take into account the unintended effects of their actions that arise from its general equilibrium consequences, as described in Section 1.9.

The union voice effect

There are other ways that unions may contribute to lower unemployment.

Suppose that, over time, the employer and the trade union develop a constructive working relationship—for example, solving problems that arise in ways that benefit both employees and the owners. The employees may interpret the employer’s recognition of the trade union, and its willingness to compromise over a higher wage, as a sign of goodwill. As a result, the employees might identify more strongly with their firm and experience effort as less of a burden than before. As a result, the employer may be able to get more work (per hour) from their employees increasing labour productivity. Or the employer may be able to pay less without workers shirking on the job, shifting the wage-setting curve down. Remember from Unit 1 that a fall in the cost to the worker of providing effort on the job shifts the WS curve downward.

Unions may raise or lower structural unemployment

We have shown three effects of the presence of a labour union, which we can now represent in the WS–PS diagram:

• The union forces the firm to pay a wage greater than the minimum necessary to induce the employees to supply the required effort: The bargaining curve, labelled WS (union), is above the wage-setting curve.
• A powerful union chooses restraint: The union understands the reasoning in the model, including the unintended consequences of the exercise of its wage-setting power and chooses not to use it. The WS (union) curve is not shifted above the WS curve.
• The union provides employees with a voice in how decisions are made: This may lower the disutility (that is, the cost) of effort and therefore reduce the lowest wage necessary to motivate employees to work effectively.

union voice effect

The union voice effect refers to the beneficial effect that a trade union, by providing a ‘voice’ to otherwise unheard workers, can have on their treatment by employers and their job satisfaction.

The effects are illustrated in Figure 2.16. In this figure, we show the case in which the equilibrium level of employment is higher and unemployment lower with the union (point E″) than without (point E). This is because the union voice effect⁠union voice effect The union voice effect refers to the beneficial effect that a trade union, by providing a ‘voice’ to otherwise unheard workers, can have on their treatment by employers and their job satisfaction.close that shifts the WS curve downwards was greater than the bargaining effect, shifting it upwards.

But it could have worked out the other way around. The bargained wage effect could have been greater than the union voice effect, in which case, the effect of unions would have been to raise structural unemployment.

This helps to explain why the data in Figure 2.15 does not show any clear correlation (either positive or negative) between the extent to which union wage contracts cover workers across the economy and the amount of unemployment.

The Swedish solidaristic wage policy discussed in the previous section was devised by the unions. As in that case, unions may also affect the average productivity of labour, which will shift the PS curve. If unions foster cooperation with management in solving production problems, the average product and the PS curve will rise (leading to higher wages and less unemployment). If unions resist productivity improvements, such as the introduction of new machinery or changes in work rules, then the effect will go in the opposite direction.

Union strength and inequality over time: The United States

When union membership peaked in the US in the 1950s, nearly 35% of employees belonged to a union. It fell to one in ten by 2018. Meanwhile, earnings inequality followed the opposite path—falling to a trough in the 1950s and rising thereafter (Figure 2.17).

The fall in the union density rate in the US was particularly fast from the early 1980s: it fell from 20.1% in 1983 to 10.5% in 2018. As a result, it became easier (less costly) for employers to fire workers whose work they find unsatisfactory. In our model, this would increase the probability that a worker would be fired if they were not working up to speed. The weakening of union bargaining power can be represented by a downward shift in the WS curve (Figure 2.14). Over the same period, other changes in the labour market—including the emergence of insecure employment in the gig economy—have reduced the reservation wage of workers and contributed to the downward shift of the WS curve.