There May be Unemployment when the Labour Market is Competitive and the Output Market is Not

Abstract

Is unemployment always caused by union power, or, more generally, downwards rigidity of wages? The influential article by Hart (i 982) says 'Yes': there cannot be unemployment unless labour unions prevent wages from falling.' The more recent papers by D'Aspremont et al. (i 984, I989 a, b) and by Dehez (i 985) say 'No': unemployment may occur when the labour market is perfectly competitive and the output market is not. All this work assumes a fixed labour supply, but the more recent models significantly depart from Hart's formulation in other respects.2 One may ask: which answer is the robust one? This paper shows that Hart's answer is based on a facilitating assumption on marginal revenue. I replace it by a more realistic hypothesis and replicate Hart's existence and comparative statics results except that now unemployment may occur when the labour market is perfectly competitive and the output market is not. More precisely, there can be unemployment at any nonnegative wage, and perfect competition in the labour market may generate zero wages and unemployment, labour becoming a free good in excess supply. A useful, costless resource is then wasted away, and thus a gross form of inefficiency occurs. In Hart (I982), on the contrary, perfect competition in the labour market necessarily yields full employment and Pareto efficiency. Labour does not often become a free good in excess supply in modern industrial economies. But this possibility may help explain why labour markets have become noncompetitive. Wages are positive at an overall Walrasian equilibrium. But imagine that the output markets become oligopolistic, and as a result the (perfectly competitive) wage drops to zero. Workers are now severely exploited in the sense of Joan Robinson (I933, Ch. 25) and Pigou (I920) because the real wage is lower than the physical marginal product of labour. Unionisation can then be seen as providing countervailing power, in