The Theory of Trade Unions: A Brief Introduction If labour markets are competitive and each individual 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 as there is no point in paying a higher wage and a lower wage results in no workers being hired. And the firm will choose the level of employment to maximize profits which leads to the first-order condition, MRPL=wage: (1.1) R '( N ) = B
This is represented in Figure 1. Figure 1
1 -1 0 -.5 Log Wage 0 .5

2 log employment log MRPL

log competitive wage

Now lets assume the workers in the firm are represented by trade unions. To decide what happens to wages and employment we need to make some assumptions about: the preferences of the union the process of bargaining between employer and union. -

The Preferences of Unions

There is a large literature debating what the objective function of a union is likely to be. But there is good reason to think that it will be increasing in the level of wages above B (unions do set out to raise wages for their members) and they care about the level of employment (they normally fight reductions in employment). A simple way of capturing these ideas is to assume that the utility function has the form: (1.2) U = N (W B ) Here can be thought of as representing the unions preference for employment relative to wages. The union will have preferences as represented by the indifference curve in Figure 2.

Figure 2
2 Log Wage -1 0 0 1

2 log employment

log MRPL union indifference curve

log competitive wage

The Process of Bargaining

Here, there are 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 o unions and employer negotiate the wage but employment is determined unilaterally by the employer. the efficient bargain model o unions and employer negotiate both the wage and employment.

The Labour Demand Curve Model.

As employers will choose the level of employment to maximize profits given the negotiated wage. This will result in a level of employment where MRPL=wage (hence the name labor demand curve model) i.e.: (1.3) R '( N ) = W The outcome will be on the labour demand curve. But where, on this curve, will be the wage be set. If the union has no bargaining power then the wage will be equal to B. Now consider the other extreme, where the union has all the bargaining power and can dictate the wage to the employer. The budget constraint is the labour demand curve and the union will choose the point on this curve that puts it on the highest possible indifference curve. This is the outcome shown in Figure 3. It is sometimes called the monopoly union outcome.

Figure 3
1 -1 0 -.5 Log Wage 0 .5 1.5

2 log employment

log MRPL union indifference curve

log competitive wage

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. 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 extreme and that the wage will be lower: the more bargaining power the employer has Note in this model that unions raise wages, reduce employment and reduce profits. A model with capital as well would predict a reduction in investment also.

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 isoprofit curves on Figure 3. The have an inverted u-shape and, more importantly, they are horizontal at all points on the labour demand curve. So, at the monopoly union outcome, the firm iso-profit curves and union indifference curves are not tangential so 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 by making both wages and employment the subject of bargaining will lead to an outcome in which all gains from trade are exploited and union indifference curves and firm iso-profit curves are tangential. But 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. What does the contract curve look like? The profits of the firm are given by:

 = R ( N ) WN

(1.4)

so that the slope of the isoprofit curves (the marginal rate of substitution) is given by: / N R ' ( N ) W = (1.5) / W N For the union with the preferences as in (1.2) we have that: 1 U / N N (W B ) (W B ) (1.6) = = U / W N N These two MRS must be equal on the contract curve which leads to: (1.7) R ' ( N ) W = (W B ) R ' ( N ) = B + (1 ) W

If = 0 then the contract curve is the labour demand curve this is not surprising as the union then does not care about employment. But if 1 > > 0 , the contract curve is to the right of the labour demand curve but employment and wages are still negatively related. If = 1 the contract curve is vertical and employment at the competitive level whatever the wage determined by the unions bargaining power. And if > 1 the contract curve has a positive slope an increase in union bargaining power now actually raises employment. So the efficient bargain model predicts that unions raise wages but has ambiguous effects on employment. Empirical Evidence There is a very large literature on the effect of unions on wages (the union wage markup). 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. There is not much in the way of 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). 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, unions may be more likely to succeed in organizing workers in large firms. It is with this background of a rather low quality of existing empirical evidence that the diNardo-Lee paper is interesting. 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:

But, the conclusion from their study is that the 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:

and in table form:

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 crosssection 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 and the fact that employers spend large sums of money trying to avoid unions.