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An Analysis of Labour Adjustment Costs in Unionized Economies

  • Modesto, Leonor


    (Universidade Catolica Portuguesa, Lisbon)

  • Thomas, Jonathan P.


    (University of Edinburgh)

In this paper we conduct a theoretical analysis of the implications of a union which can exploit the existence of firm labour adjustment costs. We consider a model involving a large number of identical firms facing a single, economy-wide union. We solve (i) for the Markov perfect equilibria with no commitment, under the assumption that the union chooses wages each period and firms react by choosing employment, and (ii) for the commitment equilibria where the union can precommit to the entire (infinite) sequence of wages. We conclude that the speed of adjustment of employment, that is higher in the no-commitment case, decreases with adjustment costs in both models. Moreover adjustment costs affect the long run values of employment and wages only in the no-commitment case, i.e., the higher the relevance of adjustment costs the higher the wage and therefore the smaller the level of employment in the long run. Commitment on the part of the union leads to lower wages, and moreover is beneficial to firms as well as to the union. Given that the union would like to commit to a lower path of wages we consider whether reputation building is desirable.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 225.

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Length: 41 pages
Date of creation: Dec 2000
Date of revision:
Publication status: published in: Labour Economics, 2001, 8 (4), 475-501
Handle: RePEc:iza:izadps:dp225
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  1. Marco Celentani & Wolfgang Pesendorfer, 1992. "Reputation in Dynamic Games," Discussion Papers 1009, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Albert Marcet & Ramon Marimon, 1992. "Communication, commitment, and growth," Discussion Paper / Institute for Empirical Macroeconomics 74, Federal Reserve Bank of Minneapolis.
  3. Lazear, Edward P, 1990. "Job Security Provisions and Employment," The Quarterly Journal of Economics, MIT Press, vol. 105(3), pages 699-726, August.
  4. Pfann, Gerald A. & Verspagen, Bart, 1989. "The structure of adjustment costs for labour in the Dutch manufacturing sector," Economics Letters, Elsevier, vol. 29(4), pages 365-371.
  5. J. Tirole & E. Maskin, 1982. "A Theory of Dynamic Oligopoly, I: Overview and Quantity Competition with Large-Fixed Costs," Working papers 320, Massachusetts Institute of Technology (MIT), Department of Economics.
  6. D. Fudenberg & D. K. Levine, 1999. "Maintaining a Reputation when Strategies are Imperfectly Observed," Levine's Working Paper Archive 571, David K. Levine.
  7. de la Croix, David & Palm, Franz & Pfann, Gerard, 1993. "A Dynamic Contracting Model for Wages and Employment in three European Economies," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 1993021, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  8. Greer, Douglas F & Rhoades, Stephen A, 1977. "A Test of the Reserve Labour Hypothesis," Economic Journal, Royal Economic Society, vol. 87(346), pages 290-99, June.
  9. Bertola, Giuseppe, 1990. "Job security, employment and wages," European Economic Review, Elsevier, vol. 34(4), pages 851-879, June.
  10. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
  11. Nickell, Stephen, 1979. "Unemployment and the structure of labor costs," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 11(1), pages 187-222, January.
  12. Kennan, John, 1988. "An Econometric Analysis of Fluctuations in Aggregate Labor Supply and Demand," Econometrica, Econometric Society, vol. 56(2), pages 317-33, March.
  13. Hamermesh, Daniel S. & Pfann, Gerard Antonie, 1996. "Adjustment Costs in Factor Demand," CEPR Discussion Papers 1371, C.E.P.R. Discussion Papers.
  14. John Kennan, 1988. "Equilibrium Interpretations of Employment and Real Wage Fluctuations," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 157-216 National Bureau of Economic Research, Inc.
  15. Oswald, Andrew J, 1982. "The Microeconomic Theory of the Trade Union," Economic Journal, Royal Economic Society, vol. 92(367), pages 576-95, September.
  16. Burgess, Simon M, 1988. "Employment Adjustment in UK Manufacturing," Economic Journal, Royal Economic Society, vol. 98(389), pages 81-103, March.
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