Collective Wage Bargaining

Collective wage bargaining exists where wage rates, hours, and other general working conditions are set out in an agreement between the employers and a representative organization of the workforce. Organized representatives of workers in trades unions negotiate with employers or representative organizations of employers to reach agreements.

In standard economic theory, a firm in a perfectly competitive market will expand employment until the marginal value product of another worker exceeds the wage cost. But what sets the going wage rate for a firm? Many factors set the wage, including the skills demanded and the demand for workers in the firm's industry and other industries. In perfectly competitive markets, the demand for labor should be clear so there would be no involuntary unemployment. However, with ups and downs in the demand schedule for any industries' products, firms desire labor flexibility, that is, to reduce wages or employment during a recession and employing more workers when demand rises again. However, there is asymmetric information. Individual workers do not know how well the firm is doing at any one time beyond what they may learn from annual balance sheets and stock market prices. Managers have an incentive to pretend that times are always hard to drive down wages. Thus, unless an individual worker is thought to be irreplaceable or very hard to replace, individual workers are poorly placed to negotiate for better working conditions or higher wages. Because all workers are similarly placed, they have a collective interest in forming an organization to represent them.

An organization that represents all workers is much better placed to negotiate with the employer. It can employ people to gain a better insight into the real state of the industry and the profit potential of the firm. It can use the bargaining strength of all workers together in order to negotiate for better working conditions and wages. Such a union of workers can coordinate a strike or other activity as part of the bargaining process. By using such threats, it can force firms to pay higher wages than they would desire and force them to provide better working conditions. Such activity often goes under the name of collective wage bargaining.

However, collective wage bargaining has become recognized in many countries, for example Germany and Canada, as a specific legal entitlement of both workers and employers, with rules governing the process of negotiation. The state has become involved in the wage negotiations between private firms and workers. The theory of collective wage bargaining in such countries is that the routinized and legalized process will reduce the likelihood of strikes and other industrial activity to give more efficient procedures for wage bargaining. Why is such state-regularized collective wage bargaining thought to be better than a more anarchic system?

When a union can force wages higher than the free market equilibrium for the industry, firms will shed workers. They may do so in ways agreed by the unions. Here, there will be involuntary unemployment. Unions may accept higher wages for lower employment because they are concerned only with the collective interests of their members. However, in a world of uncertainty, and with asymmetric information, [Page 113]firms may go bust through the demands of collectivized workers that do not believe the dire warnings of managers. Firms and trade unions may find themselves in a prisoner's dilemma–type game and may find themselves locked into a noncooperative equilibrium. In other words, just as workers faced a collective action problem in forming a trade union, the union itself is in a collective action dilemma with the firms in the industry. If noncooperation increases conflict, such as strike activity, the difficulties of firms or an industry may be compounded. The theory of state-sponsored collective wage bargaining is designed to overcome that strife and solve the collective action problem.

...