The analysis of Mulder and van der Ploeg is about a small open economy with so-called dominant unions. The supply side as well as the demand side of the economy is well developed. Firms are operating on goods markets characterised by monopolistic competition and are striving for a maximisation of the discounted value of the profits. On the labour market, there is one monopoly union, which chooses the consumers’ real wage to maximise a utility function, containing net wage income, employment and unemployment benefits. The union is dominant in the sense that it has the power to set nominal wages unilaterally. The central theme of this contribution is the union’s problem of maintaining credibility with the firms when setting the wage rate rather low. The problem is especially relevant when long-term contracting is not possible. The motive of the union in setting the wage rate rather low, is to induce a rather high level of investments. But in the absence of a binding contract the union has the possibility of raising the wage level, when the desired and expected investments are realised. In that way the union squeezes the quasi capital rent. Firms who are afraid of this kind of reneging of the contracts, are not prepared to realise a high investment level. To take away that fear the union must build up a reputation ‘not to renege’ contracts.
KeywordsWage Rate Real Wage Unemployment Benefit Reaction Function Wage Level
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