Labor Economics

Summer 2018

5: Wage Bargaining and Labor Unions

Prof. Dr. Almut Balleer

Chair for Applied Economics
Introduction Demand and Supply Efficiency Summary

Introduction

Almut Balleer Labor Economics: Lecture 5 2

Introduction Demand and Supply Efficiency Summary

Introduction

• Unions mean that workers unite to bargain about employment

contracts with the firms
• Unions influence practically all aspects of the employment
contract: wages, working hours, working conditions, etc.
• Unions are often craft or industrial unions
• National union federation (AFL-CIO, DGB):
political lobbying, coordination of different unions
• Unions attempt to maximize the well-being of their members
• Questions:
• How do unions affect labor market outcomes?
• How to evaluate the influence of unions?

Almut Balleer Labor Economics: Lecture 5 3

Introduction Demand and Supply Efficiency Summary

Demand for and Supply of Unions

Almut Balleer Labor Economics: Lecture 5 4

Introduction Demand and Supply Efficiency Summary

Review: Labor market equilibrium

• Labor market equilibrium coordinates the desires of firms and
workers, determining the wage and employment observed in
the labor market.

Almut Balleer Labor Economics: Lecture 5 5

Introduction Demand and Supply Efficiency Summary

Review: Marshall’s rules

• Marshall’s rules state that labor demand is more elastic when
• The elasticity of demand for the firms output is greater: Wage
increases increase the cost of production and therefore the
output price. Consumers buy less when the output price
increases and lower production translates into lower labor
input.
• Labors share in total costs of production is greater:
Labor-intensive industries have a high labor share in
production. The cost of production increases strongly when
the wage increases.
• The elasticity of substitution is greater: Firms can easily
substitute labor for capital as the wage increases.
• The elasticity of supply of other factors of production such as
capital is greater: Increasing capital means price of capital
increases moderately.

Almut Balleer Labor Economics: Lecture 5 6

Introduction Demand and Supply Efficiency Summary

Marshall’s rules and Unions

• Collective bargaining will increase the wage (monopoly

supplier of labor)
• Firms may respond by lower employment (moving up the
demand curve)
• Unions are more successful, i.e. ensure better outcomes, when
labor demand is inelastic (higher wages, stable employment)
• Can unions influence the elasticity of demand?
• Opposing technical change that affects substitutability
between inputs
• Opposing international trade
• Craft unions rather than universal unions
• Prevailing wages

Almut Balleer Labor Economics: Lecture 5 7

Introduction Demand and Supply Efficiency Summary

The Behavior of Monopoly Unions

• The competitive wage-employment combination is given by w ? and

E?
• A monopoly union maximizes utility by choosing the point on the
firms labor demand curve, D, that is tangent to the unions
indifference curve
Almut Balleer Labor Economics: Lecture 5 8
Introduction Demand and Supply Efficiency Summary

The Behavior of Monopoly Unions

• The union demands a wage of wM and the employer cuts back

employment to EM
• If the demand curve were inelastic (as in D 0 ), the union could
demand a higher wage, experience fewer employment cuts, and
receive more utility
Almut Balleer Labor Economics: Lecture 5 9
Introduction Demand and Supply Efficiency Summary

The Demand for Union Jobs

• A worker joins a union if the union offers him or her a

wage-employment (benefit) package that provides more utility
net of union dues than the wage-employment package offered
by a nonunion employer.
• The demand for union jobs depends on the size of the wage
increase, the amount of employment loss, and the costs of
union membership.
• US: Union fees average about one percent of each workers
annual income.

Almut Balleer Labor Economics: Lecture 5 10

Introduction Demand and Supply Efficiency Summary

The Demand Supply of Union Jobs

• If a firms demand curve for labor is inelastic the employment

reduction is small (and vice versa).
• The supply of union jobs depends on
• the ability to organize a workforce
• the legal environment affecting union activities
• the resistance of management
• whether a firm is making excess rents (market structure)

Almut Balleer Labor Economics: Lecture 5 11

Introduction Demand and Supply Efficiency Summary

The Decision to Join a Union

• The budget line is given by AT, and the worker maximizes utility at
point P by working h? hours
• The proposed union wage increase (from w ? to wU ) shifts the
budget line to BT
Almut Balleer Labor Economics: Lecture 5 12
Introduction Demand and Supply Efficiency Summary

The Decision to Join a Union

• If the employer cuts back hours of work to h0 , the worker is worse off
• If the employer cuts back hours only to h1 , the worker is better off

Almut Balleer Labor Economics: Lecture 5 13

Introduction Demand and Supply Efficiency Summary

Unions in the United States

Union Membership in the United States, 1900-2012

• Private-sector unionization rose between 1930 and 1960 (from

8% to 25%) and then began a steady decline (to under 15%
by the 2000s).

Almut Balleer Labor Economics: Lecture 5 14

Introduction Demand and Supply Efficiency Summary

Unions in the United States

Union Membership in the United States, 1900-2012

• Prior to the Great Depression, the public did not favor unions.
• Under the New Deal in the 1930s, the legal environment
treating unions and employers changed.

Almut Balleer Labor Economics: Lecture 5 15

Introduction Demand and Supply Efficiency Summary

Unions in the United States

Union Membership in the Public Sector, 1962-2012

• Public sector unionization increased dramatically during the

1970s and coverage has remained above 35% since.
Almut Balleer Labor Economics: Lecture 5 16
Introduction Demand and Supply Efficiency Summary

Grundlagen und Entwicklung von Gewerkschaften

Unions in Germany 13

Abb. 3: Entwicklung der Mitgliederzahlen von DGB und DBB, normiert auf 100 in 2005

Entwicklung der Mitgliederzahlen von DGB und DBB

102%
100%
98%
Veränderung in %

96%
94% DGB
92% DBB
90%
88%
86%
84%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

(Quelle: in Anlehnung an DGB 2015; DBB 2015b)

Verfolgt man nunUnion Membership

die Entwicklung in Germany,
einzelner Gewerkschaften des2005-2014
DGBs, so fällt auf, dass
sowohl im Dienstleistungs- bzw. öffentlichen Sektor, als auch innerhalb des industriellen Be-
reiches ein Rückgang der Mitgliederzahlen stattgefunden hat (vgl. Abb. 4).

Abb. 4: Mitgliederentwicklung einzelner Gewerkschaften des DGB, normiert auf 100 in 2005

Almut Balleer Labor Economics: Lecture 5 17

Introduction Demand and Supply Efficiency Summary

Why Has Union Membership Declined?

• Different job/occupations have different unionization rates

• The structure of the economy and thus labor market has been
changing since the 1960s
• Blue collar workers are less prevalent
• There has been a marked increase in labor force participation
rates of women
• Legislation: Jobs have shifted to right-to-work states.
• Firms have become more resistant to unions.
• Workers demand for union jobs has declined.

Almut Balleer Labor Economics: Lecture 5 18

Introduction Demand and Supply Efficiency Summary

The Union Wage Gap

• We cannot easily calculate the union effect on wages, since we

often do not know what a worker would earn outside the
union.
• We rely on a calculation of a union wage gap, a percent
difference between union and nonunion wages:
wU − wN
Union wage gap = D =
wN
• The union wage gap overestimates the union wage gain,
because a typical worker in a union job will be more
productive than workers in a non-union job. (Skimming)

Almut Balleer Labor Economics: Lecture 5 19

Introduction Demand and Supply Efficiency Summary

The Union Wage Gap

Wage Gap Between Union and Nonunion Workers, 1920-2012

• The union wage gap has fluctuated greatly over time, but
since the 1970s it has hovered between 15 and 20 percent. In
2007, the average union wage gap was estimated to be 16
percent.
Almut Balleer Labor Economics: Lecture 5 20
Introduction Demand and Supply Efficiency Summary

The Union Wage Gap

• The existence of a union sector has two side effects on the
nonunion sector.
• Threat effects involve nonunion firms offering higher wages to
reduce incentives of workers to unionize. (The threat effect
leads the union wage gap to be underestimated.)
• Spillover effects result when workers unemployed in the union
sector enter the nonunion sector, thus increasing the supply of
labor and decreasing nonunion wages. (The spillover effect
leads the union wage gap to be overestimated.)
• Fringe benefits and other job amenities
• The fringe benefits package received by union workers is
generally worth more than the package received by nonunion
workers.
• The union compensation gap may be 2 or 3 percentage points
higher than the union wage gap.

Almut Balleer Labor Economics: Lecture 5 21

Introduction Demand and Supply Efficiency Summary

Unions and Wage Dispersion

• Unions equalize wages (average of different individual

marginal productivities)
• The dispersion of wages in the unionized sector is 25 percent
less than the dispersion of wages in the non-unionized sector.
• Unionized firms offer a lower payoff to education than
non-unionized firms.
• Unions flatten the age-earnings profile.

Almut Balleer Labor Economics: Lecture 5 22

Introduction Demand and Supply Efficiency Summary

Review: Increase in Inequality

Earnings Inequality for Full-Time, Year-Round Workers, 1963-2005: The 80-50 Wage Gap

• Is there a relationship between unionization and inequality?

Almut Balleer Labor Economics: Lecture 5 23

Introduction Demand and Supply Efficiency Summary

Efficiency

Almut Balleer Labor Economics: Lecture 5 24

Introduction Demand and Supply Efficiency Summary

A Normative View on Unions

• Unions achieve higher wages for their members, i.e. they
transfer some wealth from firms to workers
• In case of elastic labor demand, unions influence lowers
employment, increases output prices and lowers output
• Does lower output lead to lower welfare? What is the efficient
outcome?
• How is the efficient outcome shared? Trade-off between
redistribution of wealth via unions versus other redistribution
(taxes, etc.)
• Short-run versus long-run: Labor demand becomes more
elastic in the long-run (compare lecture 1), i.e. negative
employment effects may be larger in the long-run
• Macroeconomic aspects: Demand-side effects of higher wages:
Higher consumption and higher labor demand
Almut Balleer Labor Economics: Lecture 5 25
Introduction Demand and Supply Efficiency Summary

Unions and Market Efficiency

• Labor demand in two sectors, assume inelastic labor supply

• In the absence of unions, the competitive wage is w ? and national
income is given by the sum of the areas ABCD and A0 BCD 0
Almut Balleer Labor Economics: Lecture 5 26
Introduction Demand and Supply Efficiency Summary

Unions and Market Efficiency

• Unions increase the wage in sector 1 to wU

• The displaced workers move to sector 2, lowering the nonunion
wage to wN .
Almut Balleer Labor Economics: Lecture 5 27
Introduction Demand and Supply Efficiency Summary

Unions and Market Efficiency

• National income is now given by the sum of areas AEGD and

A0 FGD 0 . The misallocation of labor reduces national income by the
area of the triangle EBF.
• One estimate of the loss in national income is approximately 0.11
percent, a relatively small cost.
Almut Balleer Labor Economics: Lecture 5 28
Introduction Demand and Supply Efficiency Summary

Efficient Bargaining

• Monopoly unions set wages given firms labor demand

• Monopoly unions lead inefficient outcomes
• Possible bargaining: The firm and the union could make a
deal that makes at least one of them better off without
making the other worse off.
• The efficient contract curve lies to the right of the labor
demand curve.
• Efficient contracts imply that unions and employers bargain
over wages and employment.
• Empirical studies have found that wage-employment outcomes
in unionized firms do not lie on the labor demand curve,
which supports the standard union bargaining model.

Almut Balleer Labor Economics: Lecture 5 29

Introduction Demand and Supply Efficiency Summary

Efficient Contracts and the Contract Curve

• Labor demand is derived by profit maximization of firms given costs

• Different points along the demand function correspond to different
optimal profit levels for different wages
• Isoprofit curves show wage-employment combinations for constant
profits, profits increase to the lower-right
Almut Balleer Labor Economics: Lecture 5 30
Introduction Demand and Supply Efficiency Summary

Efficient Contracts and the Contract Curve

• At the competitive wage w ? , the employer hires E ? workers

• A monopoly union moves the firm to point M, demanding a wage of
wM

Almut Balleer Labor Economics: Lecture 5 31

Introduction Demand and Supply Efficiency Summary

Efficient Contracts and the Contract Curve

• Both the union and firm are better off by moving off the demand
curve
• At point R, the union is better off, and the firm is not worse off
than at point M
• At point Q, the employer is better off, but the union is not worse off
Almut Balleer Labor Economics: Lecture 5 32
Introduction Demand and Supply Efficiency Summary

Efficient Contracts and the Contract Curve

• If all bargaining opportunities between the two parties are

exhausted, the union and firm agree to a wage-employment
combination on the contract curve PZ
• Employment is higher than E ? along the contract curve
(featherbedding: share tasks among workers)
Almut Balleer Labor Economics: Lecture 5 33
Introduction Demand and Supply Efficiency Summary

Strongly Efficient Contracts: A Vertical Contract Curve

• If the contract curve is vertical, the unionized firm is hiring the

competitive level of employment (strongly efficient contract)
• Strongly efficient contracts also imply allocative efficiency

Almut Balleer Labor Economics: Lecture 5 34

Introduction Demand and Supply Efficiency Summary

Strongly Efficient Contracts: A Vertical Contract Curve

• The union and firm are then splitting a fixed-size pie as they move
up and down the contract curve
• At point P, the employer keeps all the rents
• At point Z, the union gets all the rents.

Almut Balleer Labor Economics: Lecture 5 35

Introduction Demand and Supply Efficiency Summary

Strikes

• A strike occurs when neither party is willing to give in when

negotiating.
• Because strikes are costly due to lost production time, strikes
shrink the amount of rents over which the parties are
negotiating.
• When parties have good information about the costs and
likely outcome of a strike, then it is irrational to strike.
• The fact that irrational strikes occur is known as the Hicks
Paradox.

Almut Balleer Labor Economics: Lecture 5 36

Introduction Demand and Supply Efficiency Summary

The Hicks Paradox: Strikes are not Pareto Optimal

• The firm makes the offer at point RF , keeping $75 and giving the
union $25
• The union wants point RU , getting $75 for its members and giving
the firm $25.
• The parties do not come to an agreement and a strike occurs.
Almut Balleer Labor Economics: Lecture 5 37
Introduction Demand and Supply Efficiency Summary

The Hicks Paradox: Strikes are not Pareto Optimal

• The strike is costly, and the post-strike settlement occurs at point

S; each party keeps $40
• Both parties could have agreed to a pre-strike settlement at point
R ? , and both parties would have been better off.

Almut Balleer Labor Economics: Lecture 5 38

Introduction Demand and Supply Efficiency Summary

Strikes and Asymmetric Information

• Strikes can be optimal if workers are not well informed about

the firms financial status.
• Since the union will experience losses during a strike, it will
reduce its demands throughout the duration of a strike.
• A firm knows that the union will moderate its demands over
time.
• A firm incurs costs during a strike, so it will chooses a strike
duration that maximizes the present value of profits.
• Strikes are more (less) likely to occur and last longer (shorter)
the higher (lower) the wage demand.

Almut Balleer Labor Economics: Lecture 5 39

Introduction Demand and Supply Efficiency Summary

Empirical Facts on Strike Activity

• Unions tend not to make high wage demands during periods

of high unemployment
• Strikes are more frequent when real wages are growing slowly
or during inflation.
• Strikes are more likely when a firm has a more volatile stock
value.
• On average, a strike reduces the value of shareholders wealth
by about 3 percent.
• The fraction of work time lost due to strike activity was only
0.02 percent in 1996 in the US.

Almut Balleer Labor Economics: Lecture 5 40

Introduction Demand and Supply Efficiency Summary

Strike Activity in the United States, 1967-2010

Almut Balleer Labor Economics: Lecture 5 41

Introduction Demand and Supply Efficiency Summary

Strike Activity in the United States, 1967-2010

Almut Balleer Labor Economics: Lecture 5 42

Introduction Demand and Supply Efficiency Summary

A Normative View on Unions

• Leisure, working conditions, etc. affect workers utility

• Unions may have important non-wage effects
• Unions give workers an option of voicing problems through a
formal grievance procedure, instead of exiting the firm when
they are unhappy.
• This implies that worker turnover should be lower in unionized
firms.
• As labor turnover declines, worker productivity increases.
• Profits rise but not enough to cover the increased labor costs.
• Lower working hours or work-sharing (layoffs, short-time work)
supported by unions

Almut Balleer Labor Economics: Lecture 5 43

Introduction Demand and Supply Efficiency Summary

Summary

Almut Balleer Labor Economics: Lecture 5 44

Introduction Demand and Supply Efficiency Summary

Summary

• Unions mean that workers unite to bargain about employment

contracts with the firms
• Unions achieve higher wages than competitive wages,
employment may fall
• Unions effectiveness and popularity depends on the elasticity
of labor demand, legal constraints, and many other aspects
• Monopoly unions versus efficient bargaining versus efficient
allocation

Almut Balleer Labor Economics: Lecture 5 45