Employment and Unions

1. Employment and Unions Andrew E. Clark (Paris School of Economicsand IZA) http://www.parisschoolofeconomics.com/clark-andrew/ APE/ETE Masters Course

2. The study of institutions, how we came to have them, and what effect they have on economic outcomes is a growing topic in Economics. And arguably is a move towards a more unified social science (maybe). • Common or Civil Law • Central Bank Independence • Divorce Law • Minimum Wages/EPL • Trades Unions I consider the last of these here, and especially wonder about the effect on employment.

3. Online OECD Employment database http://www.oecd.org/document/34/0,3343,en_2649_33927_40917154_1_1_1_1,00.html#union

7. Wages b LD Lb L Let’s meet an old friend: The labour demand curve. This shows how employment is determined in a competitive market.

8. Wages 1 > 0 w* 0 1 LD L* The labour demand curve is defined by the choice of employment to maximise profit at a given wage.

9. Derive this formally. • = pF(L) – wL Along an iso-profit curve, d=0. Totally differentiate: d = pF’(L)dL – wdL –Ldw = 0 So dw/dL = (pF’(L)-w)/L dw/dL = 0 where pF’(L) =w, which is the equation of the labour demand curve.

10. A key difference between workers (labour) and other inputs (land, materials, machinery): workers can express themselves, and bargain. In particular, they cannot be forced to work. They can form unions. What are the implications of trades unions for the level of employment? Both at the firm (micro) and the economy (macro) level. Macro is not  micro: representative agents may lead us astray…

11. Empirical regularities regarding unions. 1) Productivity: • Higher union wages might “shock” the firm into being more productive (bof). • Improvements in worker morale and cooperation: union provides a “collective voice” (rather than exit). Implication of b): labour turnover should be lower amongst union members, ceteris paribus. c) Protect membership and block innovation (Luddites). Which reduces worker effort

12. Empirical evidence from the US has produced only mixed evidence: some positive, some negative. This is true in both levels and growth UK evidence suggests a lower productivity level; results in terms of productivity growth are again mixed. Bear in mind that productivity is famously difficult to measure, and is most often calculated as a residual.

13. 2) Capital: The other factor of production • Unions tend to be associated with lower levels of physical investment and R&D. • But unions are associated with greater levels of worker training. 3) Working Conditions: A positive effect (unsurprising) 4) Wages: Unions are associated with higher worker wages; they are also associated with lower wage inequality (the wage effects of unions are felt most strongly for the low-paid.

14. 5) Job Satisfaction: Typically found to be negative. • Careful of causality (desire for union representation is negatively correlated with satisfaction) • Are union jobs really worse, or do unions just allow people to moan more (give them a voice)? Test this via an objective correlate of satisfaction: quits. Model: quit = q(X, satisfaction, union, union*satisfaction).

15. It’s actually not that obvious to come to a conclusion about the union wage effect. The union wage differential is given by: di=(wiU-wiN)/wiN In practice, we don’t observe the same individual “i” as both a union member and a non-union member. We thus compare across individuals: d=(wU-wN)/wN

16. Problem is that union members (who give us the wU) might have very different observed and unobserved characteristics to non-union members (who supply the wN figure). Omitted variable bias. Recent estimate of the union mark-up in the UK are around 7-12%. Higher for manual and low-skilled workers (wage compression, as noted above).

17. What happens when workers unionise? Union utility function: U =Lu(w) + (M-L)u(b) M is union membership. Totally differentiate for the indifference curve: dLu(w) + Lu’(w)dw – u(b)dL = 0 So dw/dL= -[u(w)-u(b)]/Lu’(w)

18. I1 I2 I0 Wages b L Utility increases North-Westwards. Negatively-sloped as long as u(w) > u(b): indifference curves become horizontal at w=b.

19. I1 I2 I0 Wages wMU LD LMU L Models of Union Behaviour • MONOPOLY UNION The union makes all of the decisions here, by choosing both the level of wages and the level of employment, subject only to the constraint that the final point be on the labour demand curve.

20. 2) RIGHT TO MANAGE More realistic. Employment is chosen by the firm, wages are bargained over. Nash bargaining solution Max B = [Lu(w)+(M-L)u(b)][pF(L)-wL] 1- w s.t. the labour demand curve (pF’(L)-wL) The parameter  reflects the union’s relative bargaining power. If =0 then the firm has all the bargaining power; If =1 then the union has all the bargaining power;

21. I1 Wages =1: Monopoly Union wMU =0: Competitive (no union) b LD L RTM solution is somewhere along the LD curve, between wMU and b.

22. Both the Monopoly Union and the RTM models have the implication that higher wages are associated with lower employment: because we are moving up and down the labour demand curve. All of the MU/RTM solutions are on the labour demand curve. All of these solutions are (in general…) inefficient. We therefore turn to the….

23. 3) EFFICIENT BARGAIN Here both wages and employment are negotiated between the firm and the union. We have the same Nash maximand as above, but now maximised over both w and L. The EB reflects the general principle that for efficiency, we should always bargain over all of the elements upon which our utility depends. Only let others decide when we do not care (when our utility does not depend on them).

24. I1 I2 Wages wMU 1 LD L An EB point is not The MU point is inefficient Efficient points are given by the tangent between the IC and the iso-profit curve. At any other point, we can make one of the firm and the union better off without making the other one worse off. Tracing these out produces an upward-sloping curve in (w, L) space. Note that when indifference curves are flat, the tangent to the iso-profit curve will be on the labour demand curve. This is true at w=b.

25. CC I1 Wages wMU b 1 LD 0 L CC = the Contract Curve

26. In the EB model, there is a positive relationship between wages and employment. Moving up the CC curve implies greater union bargaining power. The union takes part of the payoff of more power in wages, part in employment. The problem with the EB is that it doesn’t seem to describe the real world very well. While unions do negotiate over wages, they most often probably don’t negotiate over employment. Therefore in most of the bargains that we observe, higher wages are associated with lower employment. As we now that unions are associated with higher wages, surely it’s a no-brainer to say that they reduce employment?

27. The Macroeconomics of Trade Unions • The microeconomic analysis above was partial equilibrium. We didn’t consider the effect of one firm’s wage and employment decisions on other firms. • In the macro analysis, we will take these effects on board. This changes the results. • Consider an economy with trade unions. There are a number of different dimensions along which we can describe the “degree of unionisation” of that economy. • The percentage of workers who are union members (Union Density) • The percentage of workers who have their pay and working conditions decided by union bargaining (Collective Bargaining Coverage) • How many unions there are • At which level do unions bargain: firm, industry, economy? (Degree of centralisation) • Do different unions coordinate their bargaining activities? (Degree of coordination)

28. Inspiration for this literature The wildly different macro performances of OECD countries in the 1970s and 1980s following the first two oil-price shocks. Some, such as Japan, Austria and the Nordic countries, seemed to have levels of unemployment and inflation that were persistently lower than those in other countries. The bad pupils: the rest of Western Europe, and North America. Different macro performance could come from macro variables (interest rates, exchange rates…) …or from institutions. We here particularly think of trades unions.

29. The initial focus of this work was on bargaining centralisation. This can range from the establishment-level right up to the country level. Branch/ Industry Establishment Firm Country OECD countries operate at wildly-different points on this scale: see my attempt at a ranking in Table 3.3. of the Employment Outlook chapter. Nordics to the right; N. America to the left; much of Western Europe in the middle There is movement between countries, and within countries over time.

30. So what? • We are interested in this because of its potential impact on economic performance. • A distinction (vastly oversimplified): • “Eurosclerosis” school: centralised bargaining is a rigidity which prevents labour markets from clearing • “Corporatists” believe that centralised institutions may help us to overcome market failure. • Both imagine a linear relationship between bargaining centralisation and performance: this assumption was challenged in a well-known paper by Calmfors and Driffill in Economic Policy in 1988.

31. CD do think that there is a ranking in terms of centralisation and economic performance; they just suggest that the middle is worse than the two ends. Initial analysis carried out in terms of the unemployment rate. Unemployment Centralisation Based on two key elements: the first is externalities.

32. Externalities • Are others hurt by the higher wage a union bargains for its members? • My members receive higher wages, and are thus happy. • What about others? • Calmfors (1993) identifies six potential routes via which higher wages for a union might reduce the utility of those not covered by the bargain. • Consumption prices (lower real wages) • Input prices • Fiscal effect (have to pay for others’ unemployment) • Unemployment (less chance of getting another job if you are yourself unemployed).

33. 5) Relative utility: u=u(y/y*) 6) Efficiency wages. If e=e(y/y*), then effort by uncovered workers will fall. Suppose that individuals are not altruistic. To what extent will these externalities be taken into account? Decentralised bargaining will take none of them into account: those who profit from higher wages represent only a small percentage of those who are hurt by them. As we move from left to right on the centralisation scale, negations cover a greater percentage of people: we take more notice of the costs of higher wages relative to their benefits. At the logical extreme, if we bargain for everyone in the country, then those who profit and those who are hurt are the same people: externalities are internalised.

34. Internalising externalities leads to wage moderation. The relationship between centralisation and wages is negative, therefore so is that between centralisation and unemployment. Unemployment, wages Centralisation The second key element is the price elasticity of demand, which determines the derived elasticity of labour demand.

35. By what percentage will employment fall if wages rise by 10%? Monopolists pass all of the wage increase onto prices, if demand is totally inelastic, so there is no employment effect. As the number of rival products or substitutes rises, the price elasticity of demand rises, and so does the elasticity of labour demand. Under perfect competition, only a slight increase in wages and thus price leads the firm to lose all of its market. Price elasticity imposes market discipline: the lower is the level of centralisation, the more market substitutes there are, the greater is the elasticity. Decentralisation brings wage moderation

36. Unemployment, wages Centralisation Put these two elements (internalisation and elasticity) together and you’ve got what? CD argue that this produces a hump-shaped relationship between unemployment and centralisation. I reckon they might be right; but I also think it could produce all kinds of other shapes too.

37. Let’s take it to the data to decide. • CD used four performance indicators. • Unemployment rate • Employment rate • Okun Index • API • 17 OECD countries, 1974-1985. • Classified according to centralisation of the collective bargaining system; split up into three groups. • First two columns in each panel of Table 3.2 show CD’s results.

39. Unemployment rate Centralised best; unemployment is hump-shaped. Less obvious when updated. Employment rate U-shaped in 1974-’85. Less obvious when updated. Okun Index Not U-shaped. API Sort of hump-shaped, perhaps.

40. Drawbacks of CD No statistical testing. Some of these means (many?) are not significantly different from each other. Doesn’t take into account density, CB coverage or coordination. Countries are assumed to have the same classification over a 20-year period, even though there is substantial movement. Update CD to mid-90’s. Add Spain and Portugal. And run regressions. Classifications of countries in Table 3.3. A) TU Density. France is strange. TU density has been drifting downwards. OECD Trade Union Density: 198019901994 46% 40% 40%

41. B) CB coverage is usually greater than membership. See Figure 3.1. OECD Collective Bargaining Coverage: 198019901994 72% 70% 68% C) Centralisation. Higher in Nordic countries; lower in Canada, Japan, NZ and the US. A decentralisation tendency in the UK, Australia, Denmark and NZ. A centralisation tendency in Italy and Portugal. D) Centralisation is no use if centralised agreements are renegotiated at more local levels. Take union coordination into account. This is higher in Austria, Germany and Japan; lower in Canada, the UK, NZ and the US. A tendency towards less coordination.

42. One of the big issues in this literature has been the wild proliferation of indices. • There are as many indices of country bargaining regimes as there are authors, I reckon. • Happily, they do seem to be pretty well correlated (see Table 3.4). • Simple correlations • I have five macro performance indicators (five-year averages) • Unemployment rate • Employment rate • Inflation • Real wage growth • Wage inequality

44. Table 3.5 shows Spearman rank correlation coefficients. Thus looking for a linear relationship. Not much comes out of that (although unions associated with less wage inequality). To identify non-linearities, recode rank. Instead of 1, 2, ….., 18, 19 use an ascending-descending rank (middle worse or better than ends?): 1, 2, …, 8, 9, 10, 9, 8, ….2, 1. Any positive correlation implies middle-ranked countries have more of whatever it is we’re looking at than the ends do. Only result: a hump-shape with inflation, but even this goes away by 1994.

45. Pooled Regressions. Make up dummies for centralised/coordinated and intermediate. Countries can change classification over time. OLS regressions in Table 3.6. 57 observations. TU membership: + E, - inequality CB coverage: + unemployment, inflation, -E Centralised: - unemployment, inflation, inequality Intermediate: - inflation, inequality. What a mixed picture. One thing we can say is that there is no evidence of a multivariate hump-shape. Strong inequality result. Is centralised best after all?

47. Fixed-Effect Regressions. Look at changes within one country over time. See Figure 3.2. What happened to countries that decentralised/became less coordinated? Unemployment rose, employment fell, and inequality rose.

50. Conclusion: • Micro union theory suggests that higher wages increase unemployment. • Macro theory suggests that there is a hump-shape with respect to centralisation. • Difficult to find clear evidence. • Unions certainly raise wages. But they might raise productivity too (human capital, discourage quits, voice leading to higher effort). So we’re still on the labour demand curve, but the whole thing has shifted to the right. • We have considered only price-taking firms. When firms have market power, then the effect of wages on employment is not so clear (see Alan Manning’s Monopsony work). • All the empirical literature is probably flawed anyway: unionism is not exogenous. Find a good instrument.