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Is Collective Bargaining Pareto Efficient? A Survey of the Literature

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Abstract

It would be difficult, even today, to argue that labour unions are not important economic institutions, and it is this importance that makes their consequences for efficiency so substantial. Interest in the economic analysis of unions was revived in the early 1980s, in large part by a paper by Ian McDonald and Robert Solow, which formalized ideas first expressed in the context of labour markets 35 years earlier by Wassily Leontief. The standard textbook model of the labour union treats the union as a conventional monopoly seller of labour, selecting the wage while the firm chooses the level of employment; McDonald & Solow, however, drew from Leontief’s work to suggest an alternative in which the firm and union negotiate to a Pareto efficient contract. Further theoretical work followed, and a still-growing empirical literature began to develop; a wide variety of empirical procedures and tests have been attempted, with a diverse and contradictory range of findings. Given the importance of the question of union contract efficiency, an up-to-date survey of the literature may be useful in synthesizing past results and pointing the way to future research, and it is this role which the current paper will attempt to fill.

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Notes

  1. Statistics on union density are from Trade Union Density (2004). High union density rates are much more common in Europe than anywhere else; 2001 rates include 53.6% in Norway, 55.8% in Belgium, 73.8% in Denmark, 77.8% in Finland, and 78.0% in Sweden.

  2. See Economic Performance (1997).

  3. Excellent surveys of the larger field of research into the economics of unions are provided by Farber (1986), Pencavel (1991), Kuhn (1998), and Kaufman (2002).

  4. For a brief but informative discussion of the history of the economic theory of labour unions, see MaCurdy and Pencavel (1986).

  5. Perhaps the most cited passage from Dunlop’s book states that “An economic theory of a trade union requires that the organization be assumed to maximize (or minimize) something ...But the model is not so easily constructed since the crucial question Whose wage bill? remains.” Aside from the assertions by Ross (1948) that the trade union is a political institution that is not suited to economic analysis (he claimed that “the traditional market forces are not of compelling significance under collective bargaining. Ideas of equity and justice ...move in different channels from supply and demand”), this assessment has been widely accepted, although, as we shall see later, Dunlop’s “crucial question” of what the union maximizes remains a controversial one.

  6. Subscripts will represent derivatives.

  7. This rationale for the popularity of the Monopoly Union model is identified by MaCurdy and Pencavel (1986), among others.

  8. As will be noted later, a median-voter model can result in indifference curves which are horizontal over some range, presenting the possibility that Pareto efficiency could coincide with the labour demand curve.

  9. Pencavel (1991) argues that “most economists . . . are inclined to the view that union-management bargaining will not leave unexploited any opportunities to raise one party’s welfare that do not reduce the other party’s welfare.” However, Pencavel (1984) notes that this assumes the absence of transaction costs. Fellner (1947) explains that there may be institutional obstacles preventing union and firm from reaching efficiency, such as the firm wanting to avoid the risk inherent in specifying employment in advance.

  10. Initially, union utility is written as \(U(w, L) = N^{-1}[Lu(w) + (N - L)u(\overline{w})]\), where N represents the membership of the union; however, since N and \(\overline{w}\) are, we presume, fixed for the purpose of union wage setting, the simplified version follows immediately.

  11. This is slightly different from the notation used by McDonald and Solow; in their initial model, they separate unemployment income from disutility of work, although they later recombine them.

  12. This is true more generally in Eq. 3 as long as U L  = 0 at \(w = \overline{w}\), which seems plausible.

  13. Hall and Lilien’s vertical contract curve is a result of their assumption of zero income elasticity of labour supply; see McDonald and Solow (1981), who also demonstrate that a downward-sloping contract curve would be the result if the union acted as a commune or family. Brueckner (2001) analyses various cases in which we can specify which way the contract curve slopes.

  14. As discussed in Pencavel (1991), the asymmetric Nash bargain is that which maximizes \((U - \overline{U})^{\alpha}(\pi - \overline{\pi})^{1 - \alpha}\), for some union bargaining power α and disagreement values \(\overline{U}\) and \(\overline{\pi}\). Models using the two-stage collective bargaining structure proposed by Manning (1987) (discussed in “Alogoskoufis and Manning (1991)”) generally make use of an asymmetric Nash bargain over each of wage and employment. McDonald and Solow (1981), meanwhile, suggest a number of other possible methods of determining the equilibrium, including the existence of a dominant union or dominant firm, or some historically-determined “fair shares” division of surplus.

  15. McDonald and Solow (1981) suggest that, if it is not practical to specify the level of employment in a contract, manning agreements and “featherbedding” may allow for an approximation of the efficient outcome. Johnson (1990) and Oswald (1993) both discuss the occurrence of such procedures in reality. However, as will be discussed later, several authors have cast doubt on the idea that bargaining over such measures can actually approximate an efficient outcome.

  16. Perhaps the third most popular representation is the median-voter model, which will be discussed in “The Median-Voter Model”. Also, numerous papers have emphasized the role of seniority beyond a simple median-voter framework, including Frank (1985), Kuhn (1988) (the focus of “Kuhn (1988) and Seniority Wage Profiles”), and Kuhn and Robert (1989), who analyse a simple two-worker example of Kuhn (1988).

  17. For instance, once we allow for monopsony, labour supply may be a constraint even at union wages, and for small increases in wages due to unions (ie. remaining below the intersection of supply and demand), both the EB and MU models would predict increased employment.

  18. However, it is possible that the quantities selected of other inputs could be inefficient; when the union raises wages about the competitive level, this could provide the firm with incentive to change their use of capital inputs, possibly to use relatively more capital due to its lower relative price. Hirsch and Prasad (1995), however, argue that unionized firms will in fact have a lower capital-labour ratio, as unions impose what they term a “union tax on capital,” since the union effectively shares in some of the quasi-rents that make up the normal return to capital. Manning (1987) also identifies a potential for unions to cause underinvestment in capital.

  19. Fellner (1947) identifies reasons why full social efficiency is unlikely to result. Brown and Ashenfelter (1986), Johnson (1990), and Swanson and Andrews (2007) provide a good explanation of some of the efficiency consequences of the distinction between the MU and EB models.

  20. The Stone-Geary specification is commonly used for union preferences, and covers a wide range of preference structures and possible hypotheses about union preferences; for example, Andrews and Harrison (1998) note that, if \(\beta = \frac{1}{2}\) (or, equivalently, if \(U = k(w - \overline{w})L\)), a vertical contract curve would be the result of efficient bargaining. Johnson (1990) shows that the contract curve will be negatively sloped if \(\beta > \frac{1}{2}\), and positively sloped if \(\beta < \frac{1}{2}\).

  21. Specifically, union preferences must depend on alternative wages, and alternative wages cannot be weakly separable from wages and employment in the union utility function. Andrews and Harrison (1998) add that the MU and EB models require different sets of instrumental variables for the contract wage; they also point out that, if the union does not care about employment, the contract curve will coincide with the labour demand curve, as will be discussed in “The Median-Voter Model”, but a nested test cannot distinguish between this possibility and a Pareto inefficient result off the contract curve.

  22. Clark (1990) and Johnson (1990) both demonstrate that bargaining measures that may appear to approximate bargaining directly over employment, such as featherbedding and agreements over crew size and work-intensity, may actually lead to outcomes that are not fully efficient. Other reasons for expecting the EB model to result in outcomes that are not Pareto efficient are discussed by Layard and Nickell (1990), Heywood (1993), Manning (1994), and Chezum and Garen (1996).

  23. Blair and Crawford (1984) demonstrate that a union’s preferences, if expressed through majority voting, generally will not have a von Neumann-Morgenstern representation. It is partly for this reason that numerous papers (including Dertouzos and Pencavel 1981; Pencavel 1984; MaCurdy and Pencavel 1986; Brown and Ashenfelter 1986) have analysed data from the International Typographical Union; Brown and Ashenfelter suggest that aggregating union preferences is less problematic when, as is the case with the ITU, union members are relatively homogenous and the union is highly democratic. An excellent survey and analysis of the difficulties of specifying and estimating union preferences is provided by Pencavel (1985), as well as Pencavel (1991). Empirical analysis of union preferences given a median-voter model is performed by Farber (1978), and for a general MU model by Dertouzos and Pencavel (1981), Pencavel (1984) and Carruth and Oswald (1985).

  24. It is possible to reverse the order of the stages, but Manning finds that the resulting employment-wage sequential bargain must then reach an Efficient Bargaining outcome regardless of the levels of bargaining power; as a result, Alogoskoufis and Manning (1991) focus on the wage-then-employment ordering.

  25. An alternative form of a shifting rate of substitution between wages and employment, using an insider-outsider approach, is presented by Carruth and Oswald (1987).

  26. As discussed in Kaufman and Martinez-Vazquez (1990), this raises the question of how we define Pareto efficiency in such a case; Kaufman and Martinez-Vazquez (1990) reject the idea that an MV outcome on the labour demand curve represents an efficient contract, on the grounds that it is not optimal for all members of the union.

  27. In his paper, Oswald provides anecdotal and survey evidence to illustrate this fact, as well as the fact that firms, including non-union firms, commonly take seniority into account when making employment decisions.

  28. Martinello (1989) discusses an industry (the British Columbia wood products industry) in which such a situation could be a reality, due to the granting of many benefits which are independent of hours worked.

  29. It initially seems likely that employment should be negatively related to the alternative wage—if \(\overline{w}\) exogenously increases, it will cut the firm’s marginal revenue curve at a lower L, reducing the feasible range of employment; but this may already be captured by resulting changes in the average wage. Additionally, the membership of the union may be such that the marginal wage is always above the alternative wage.

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    Nicholas P. Lawson

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Correspondence to Nicholas P. Lawson.

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This paper began its existence as part of my Master’s Essay while I was a student at Queen’s University, where I received a great deal of helpful advice and guidance from Lorne Carmichael, Charles Beach, and Marvin McInnis, for which I am very thankful. I would also like to thank Orley Ashenfelter and an anonymous referee for further helpful comments and suggestions. Any errors or omissions are the responsibilty of the author.

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Lawson, N.P. Is Collective Bargaining Pareto Efficient? A Survey of the Literature. J Labor Res 32, 282–304 (2011). https://doi.org/10.1007/s12122-011-9112-y

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