Monopoly union wage setting, devaluation risk, and decentralized versus centralized bargaining

Abstract

In this paper we highlight the fact that a devaluation is a possible outcome generated by a ‘too high’ real wage, which has to be taken into consideration by wage setters. Wage setting is addressed in a standard monopoly trade union model amended with a devaluation risk component and we model both decentralized and centralized wage setting. We show how the real wage rate is determined in relation to a wage set in a corresponding problem, where the devaluation risk is zero. We also distinguish between, and compare, decentralized and centralized wage setting. The former being defined as a situation where the trade union does not perceive that its own wage setting behavior directly and/or indirectly affects the devaluation risk. In particular, we show that one would, in general, expect greater wage restraint from a more centralized bargaining system, but that there is an interesting exception to this, namely, ‘over- compensation behavior’. This is characterized by an ex post utility after a devaluation which exceeds the corresponding utility in a fixed exchange rate scenario. Finally, ‘credibility’ considerations are modelled, and we show that a more credible fixed exchange rate will usually lead to wage restraint.