Organized Labor and the Political Economy of Product Market Distortions

Abstract

Why are economic reforms reversed through strikes and demonstrations in some countries, but backed by the labor movement in other countries? Why do product and labor market distortions differ so much across countries? This article addresses these questions by means of a simple, heuristic model of the economy that replicates in an integrated manner several independent results from the recent political economy literature. Unlike most of this literature, however, the model focuses on the role played by organized labor, rather than by rent-seeking firms and guilds. A two-stage game between the government and organized labor determines the level of product market distortions (for example, import tariffs). In the first stage, the players may undertake costly actions, such as redistributing income or striking, in order to increase their bargaining power. In the second stage, they negotiate over product market distortions and wages. Under very general assumptions, several policy regimes exist: changes in the key parameters of the economy may trigger a switch in the strategy of trade unions from confrontation to cooperation and hence change the policy regime. Cross-country data highlight that, in spite of its simplicity, the model reproduces some observed empirical regularities.