Employment Policy in a Model with a Rational Trade Union

Abstract

We take as given the widely held view' that unemployment may occur because the real wage rate, and hence the cost of labour, is set at too high a level for profit maximising firms to employ every worker who seeks a job. Output is determined by aggregate supply at this real wage, and aggregate demand policies merely determine the price level or the balance of trade. In this paper we suggest that unemployment may result from rational behaviour in the labour market, and examine the scope for 'supply management' policies. In Part I of the paper we set up a model where all members of the labour force are organised by a single trade union, which can set the real wage rate. The implied cost of labour then determines the employment decisions of profit maximising firms. The union sets the real wage to maximise a utility function defined over the real wage and total employment, subject to a demand for labour constraint. The utility function is discussed in Part II, where it is shown that unemployment may occur as a result of the union's optimal choice of the real wage rate. The optimal wage rate varies with the setting of government policy instruments, and we consider government employment, taxes on labour incomes, employment subsidies and unemployment pay as policy variables. The setting of these instruments determines the union's opportunity set in real wageemployment space, and the comparative statics are discussed in the second section of Part II. We assume that the government's budget must balance, and we allow either the tax on labour incomes or a lump sum tax on profits to adjust to maintain budget balance as any of the other policy instruments change. In Part III we examine two particular policy packages: a change in government employment financed by a tax on labour incomes, and an employment subsidy financed by a lump sum profits tax. Part IV contains some remarks on the model, Part V is a conclusion and an Appendix contains mathematical proofs of the results.