Trade Unions and Wages

The trade union, wages, and employment: overview

In an organisation, an individual has relatively weak bargaining power. The employer, on the other hand, has substantial knowledge about the company and the market, which gives them an advantage in negotiating wages and work conditions. To stand a better chance of getting what they want, employees can form an association to bargain collectively.

The process by which a trade union negotiates wages and work conditions with the employer on behalf of workers is called collective bargaining. The market wage rate is determined through collective bargaining. Employers can also decide how many workers to hire at this wage rate.

Changes in wage rates have a direct impact on the level of employment. With increasing wage rates, employers will hire fewer workers, which lowers employment. Conversely, the decreasing wage rates will cause employers to hire more workers, increasing employment levels.

The effects of trade unions on how wage rates are determined

The trade unions’ main function is to bargain for higher wages for workers. Before we learn how this is done, let's see how wage rates are set.

Fig. 1. - Labour market equilibrium

As you can see in Figure 1, the labour market reaches an equilibrium when firms hire L1 workers at the wage rate of W1.

The demand curve for labour is equal to the marginal revenue product of labour (MRP). This is the extra revenue the company earns by hiring one more worker.

To increase wage rates for workers, trade unions can:

1. Increase the demand for labour.

2. Decrease the supply of labour.

3. Use its power to make firms increase wages.

Changes in the wage rate can affect the demand for labour:

1. With an increasing wage rate, employers will hire fewer workers and the demand for labour will drop.

2. With a decreasing wage rate, employers will hire more workers and the demand for labour will rise.

The effects of trade unions on wages and employment in the competitive labour market

A competitive labour market is one where multiple employers compete to hire employees. In a competitive labour market, firms are not wage setters. The market itself determines the wage rate.

The market wage rate at equilibrium is W1 and the number of workers employed is L1 (See Figure 2).

Fig 2. - Effects of trade unions in the competitive labour market

Figure 2 illustrates the effect of trade unions on wages and employment in the competitive labour market.

Without trade unions, companies will hire L1 at the wage rate of W1. The labour supply curve (S) is the upward sloping curve which is also the average cost curve AC1.

If the trade union successfully bargains for a higher wage (W2), the supply of labour curve will become the kinked curve W2XS. Employment falls from L1 to L2 while wages increase from W1 to W2.

At the wage rate of W2, there is unemployment, depicted as the distance L3 - L2.

Due to this effect, economists believe that trade unions can lead to inefficiency and unemployment.

Fig. 3. - Trade unions shift the supply curve

Besides direct negotiation with employers, trade unions can influence the wage rate by establishing closed shops (keeping all non-members out of the labour force) or carrying out longer training for under-skilled workers. This will increase the control of trade unions over the labour force while creating a shortage of labour. Employers have to increase wages to meet the labour demand. This is shown in Figure 3 above.

The effects of trade unions on wages and employment in a monopsony market

A monopsony labour market is the opposite of a competitive labour market. While a competitive labour market is characterised by a large number of employers with access to a higher number of workers, a monopsony labour market only has one employer.

Fig. 4 - Monopsony labour market

In the monopsony labour market, the marginal cost of hiring one more worker (MC) is higher than the average cost of labour (AC1). This is because firms have to pay extra to attract new workers to the market.

However, they don't have to pay workers the wage rate of W3. They only need to pay between W1 and W2: just enough to motivate people to join the workforce. (See Figure 4).

Fig 5. - Effects of trade unions in the monopsony labour market

Figure 5 illustrates the effect of trade unions on wages and unemployment in the monopsony labour market.

As you can see in the graph, the entry of a trade union 'kinks' the supply curve of labour (S) and creates a gap in the marginal cost curve for labour (MC).

Since monopsonists have incentives to employ more workers as long as the marginal cost of labour is less than the marginal revenue product of labour (MC < MRP), they will hire up to L2 workers.

The wage rate when L2 workers are hired is W2.

Factors that affect the bargaining power of a trade union

Trade unions are formed to bargain for higher wages and work better conditions for the workers. However, the effect of trade unions is not the same in all cases. Depending on the nature of the market, trade unions may have more or less influence on the determination of market wage rates.

Here are five main forces that can affect the bargaining power of trade unions:

• Trade union density: this is the percentage of the workforce in the trade union. The higher the density, the more powerful the trade union is.

• Workers’ bargaining power: the bargaining power of workers is the ability of workers to get what they want. For example, a worker working for a monopsony firm has very little bargaining power compared to a worker in a trade union with 100% density (all company’s workers are in the union).

• Economic environment: the economic environment can affect the profitability of a company. For example, companies that are thriving will be more willing to implement a wage raise than those that are struggling to survive.

• Government policies: governments can enact policies that restrict the role of the unions. For example, a government can outlaw closed shops: a place where all employees agree to join a trade union.

• The nature of the labour market: the labour market can be competitive or monopsony. In a competitive labour market, higher wages pushed by trade unions can cause unemployment. In a monopsony market, however, trade unions can bargain for higher wages without increasing unemployment.

There are also some factors that can reduce the powers of a trade union. They are:

• The growth of the gig economy such as freelance, part-time, and temporary jobs.

• The growth of the service sector at the expense of the manufacturing sector.

• The decline of the pubic-sector companies.

Pros and cons of trade unions

While trade unions act on workers' interests, their entry does not always lead to positive outcomes. In some cases, the formation of a trade union can have a negative impact on companies and the economy as a whole.

Here are some pros and cons of forming a trade union:

Table 1. Advantages and disadvantages of trade unions - StudySmarter.

Trade unions tend to work in public-sector or manufacturing industries where international trade is limited. However, the gig economy is limiting the power of trade unions in many industries. In a competitive labour market, trade unions' success in raising wages often comes at the expense of employment. However, there are cases when the trade union's push for higher wages can increase employment such as in a monopsony market.