A Microeconomic Analysis of Labor Unions
Are they Beneficial or Detrimental?
Unionization has been, and continues to be, a hotly debated topic both among economists and the general public. Discussions regarding unionization often draw both impassioned support and opposition for it. Those in support of unionization raise the issue of equity, while those who oppose unionization claim it leads to lower economic efficiency as a consequence of higher prices. A recent example of this disagreement is the failed unionization vote in April by some Amazon workers in Alabama where the workers ultimately voted against unionization. Due to its far-reaching implications, the issue of unionization is far from an easy one for courts to decide. In particular, courts have three considerations when making a decision about whether unions should be allowed to form. These considerations are the history of unions, the economic implications of unionization for a firm and its employees, and the market-wide economic implications of unionization.
Legal History of Labor Unions:
A decision about an issue as sensitive as union formation first needs to be informed by the history of labor unions. The idea behind labor unions is to collectively bargain for fairer compensation and safer workspaces. Unions became a more lucrative option during the zenith of the industrial revolution, when many workspaces often offered little in the way of compensation and worker safety. Labor unions, in the sense of being an organized movement, emerged in the 19th century in the United Kingdom, much of Europe, and the United States of America. However, they often met stiff resistance in courts, where they were stopped by statutes that prosecuted monopolization and conspiracy. The first legal foundation for unionization was the United Kingdom’s Trade-Union Act of 1871, which legalized unions and gave them protection in courts. However, the development of labor unions in the United States was more arduous. The Sherman Antitrust Act of 1890, which was meant to curb non-competitive economic practices, was mostly applied against trade unions. Only the Clayton Antitrust Act of 1914 exempted unions from being treated as an entity that is detrimental to economic growth. Thus, labor unions arose as a consequence of the industrial revolution and the new work conditions that came with it. Furthermore, they have had a long and difficult journey towards acceptance. Nowadays, unions are a commonly accepted reality of the labor market.
Microeconomic Analysis of Employment Contracts with and without Labor Unions:
Employment is, for all intents and purposes, a contract of remuneration between an employer and an employee. Therefore, one can analyze the impact of labor unions on these contracts via microeconomic analysis. As with any contract, finding employment consists of a multitude of transaction costs. These costs are search costs, bargaining costs, and enforcement costs. Bargaining costs are particularly interesting since they are the amount that is given up by a party in order to reach a successful bargain. For a potential employee, a component of the bargaining cost is the higher income that they would have asked for but have foregone to ensure a higher probability of being hired. They have an incentive to do so since employment contracts are often competitive affairs. This mutual competitiveness, and how it leads to a higher bargaining cost through a lower wage request, can be seen in a simple prisoner’s dilemma game. Supposing that only one person is hired if they request a lower wage than the other, the game is as follows:
Where y (the wage if only one person is hired due to the other asking for too much, coupled with some discounted future gain due to loyalty to the company) is the highest wage, x (the wage if both ask for a high wage and are hired due to the necessity of the work) is middling since the employer does not to spend the same high wage y for both employees, and z (the wage if both temper their requests) is the lowest of the wages. In this prisoner’s dilemma game, the only Nash equilibrium is when both potential employees ask for a low wage in order to guarantee their employment even though they could have achieved a better outcome had both of them collaborated and asked for a higher wage. This is because each employee would choose to ask for the low wage regardless of what the other employee would do. The non-cooperative wage bargaining game is an example of how high transaction costs (which stems from high bargaining costs due to potential employment rejection) can stunt bargaining’s power to produce efficient outcomes. This is more formally described by the Coase Theorem and its converse.
According to the Coase Theorem, sufficiently low transaction costs ensure that private bargaining leads to a socially optimal outcome regardless of who has an initial legal right to whatever is being bargained on. In other words, courts need not interfere to maximize efficiency. However, the converse to Coase’s Theorem is that the allocation of legal property rights will affect the efficiency of an outcome if there is a failure in bargaining, which is caused by sufficiently high transaction costs. Consequently, courts may choose to follow the normative Coase Theorem, which states that laws should be structured in a way that removes obstacles to private agreements. In this particular case, legalizing the formation of labor unions is in line with the normative Coase Theorem. Since labor unions facilitate collective bargaining, the wage bargaining game between potential employees is eliminated along with much of the bargaining costs. Thus, the lower transaction costs will now enable an efficient outcome to arise, without legal intervention, from the wage bargaining regardless of who has the initial legal bargaining rights. Of course, employment contracts do not only affect the negotiating parties. Rather, the entire economy is affected since firm production decisions, and consequently overall employment in the economy, are influenced by wages, which is a marginal cost for firms. To address these concerns, courts need to apply another theorem: the normative Hobbes Theorem.
Microeconomic Analysis of the Impact of Labor Unions on Labor Markets:
Ideally, courts should enable efficient private bargaining to occur without interference. However, failed private bargaining can result in inefficient outcomes. In such situations, courts should follow the normative Hobbes Theorem, which states that the law should be structured in a manner that minimizes the harm caused by failures in private bargaining. To examine the efficiency of employment contracts under labor unions, the short run and long run implications of labor unions on the labor market should be explored.
In the short run, some employers might reduce how many people they employ or perhaps shut down their operation entirely due to the increase in their marginal costs. This means that a sizeable group of employees, at least in the short run, can be left with no surplus at all. However, the workers who manage to retain their employment in the short run will enjoy a higher surplus at the expense of the firm that is employing them.
In the long run, a new group of workers who are more confident in the safety of their work and the security of their wages will be incentivized to join the market. Some may even be willing to work for a lower wage than before if they place enough consideration on the other union benefits. Whatever the case may be, the overall supply of labor is likely to increase in the long run. Both workers and employers benefit in the long run since a higher supply of labor entails a lower wage that needs to be paid. This is beneficial to the employers since their marginal costs will be lower, and it is beneficial to the employees since they will appreciate the rights they have received.
It is also worth noting Adam Smith’s opinion on the benefits of expanded worker health, which is a common theme of the policies that are requested by labor unions. He states that healthier workers are the ones who more consistently “execute the greatest quantity of work”. As a consequence, it is possible that the demand for labor can increase when employers see a healthy and, consequently, more capable workforce. Therefore, the wage mitigating effect of long run labor supply growth may be tempered by an increase in labor demand.
Thus, a successful union bargaining situation may be somewhat detrimental in the short run. However, everyone benefits once all agents have had time to adjust to the change. Overall, labor unions seem to have a short term detrimental effect for some agents and a long term boon for all agents. This further corroborates the Coase Theorem’s statement that private bargaining under sufficiently low transaction costs results in an economically efficient outcome. Furthermore, the efficiency of employment contracts under labor unions mean that the normative Hobbes Theorem need not be applied since there is no private agreement failure nor any long term harm as a consequence of the agreement.
Conclusion:
Labor unions have been, and continue to be, under much scrutiny. However, the microeconomic implications of legalizing the formation of labor unions are largely positive, especially in the long run. In particular, employees will benefit from high wages and more rights in the workplace while employers can benefit from a more confident and productive workforce. The slow but steady expansion of the legality of labor unions suggests that many courts eventually came to the same conclusions.
