Greater labour market flexibility might reduce unemployment but it can also be
detrimental to innovation and productivity. That is the conclusion of new
research by Justus Haucap and Christian Wey, published in the March
2004 issue of the Economic Journal. They conclude that policy-makers face a
fundamental trade-off between less unemployment and more innovative
activities.
To combat the high unemployment in many European countries, the OECD
and many economists demand that wages become more flexible by removing
restrictions that prevent them from reflecting local conditions. Since the
egalitarian nature of collective wage systems and suppressed wage
differentials have been identified by various economic experts as the main
cause of high unemployment, any move towards more wage flexibility is
supposed to be good for employment and economic prosperity.
But Haucap and Wey challenge this view as being too simplistic. They show
that the egalitarian nature of industry-wide wage settlements should generally
increase firms’ incentives to increase their productivity. As a consequence,
while removing the rigidities of collective wage setting can reduce
unemployment, it would also be detrimental to innovation and productivity.
The researchers argue that a firm’s incentives to increase its productivity are
not only influenced by the wages that the firm has to pay to its workers, but
also by the firm’s competitive position in the market. This position, however,
also depends on the wages that rival firms have to pay. The lower the wages
that rival firms have to pay, the more difficult it is to compete for a firm.
Accordingly, a firm’s innovation incentives are not only affected by its
expectations about its own wage adjustments following a productivity
increase, but also by its expectations about wage adjustments in rival firms. If
a firm expects that unions are willing to make concessions to less innovative
and less productive rivals, its own incentives to boost its productivity are
accordingly reduced.
In contrast, if wage demands cannot be moderated for less productive firms
so that wages are rigid across firms, innovation incentives increase because a
firm’s innovation and productivity improvements will translate directly into a
competitive advantage in the product market.
Among the modes of labour market organisation analysed by Haucap and
Wey, the worst labour market regime in terms of both employment levels and
innovation incentives is a centralised or co-ordinated labour market regime
where centralised monopoly unions are allowed to adjust wages to firmspecific
conditions. While the monopoly element of the regime leads to high
wages and low employment levels, the flexibility element reduces innovation
incentives.
This regime is comparable with a price-discriminating input monopolist,
something usually not liked in antitrust analysis. In contrast, a decentralised
labour market regime leads to higher employment levels, even though the
innovation incentives can be lower than under a centralised regime where all
firms have to pay the same wage rate, independent from their firm-specific
productivity.
Overall, policy-makers face a trade-off between more employment and
innovative activity. Interestingly though, allowing for an industry union and
wage flexibility at the firm level is the least preferable regime.
In light of their analysis, Haucap and Wey call for an extension of antitrust
rules to labour markets. A strict application of antitrust rules would mean that
the formation of industry-wide unions and collective wage agreements should
not be allowed due to their monopolisation effects.
While such a prohibition may imply lower productivity, the authors predict that
employment would increase. If, however, the creation of monopoly unions is
allowed for some reason, another antitrust rule may come into force, namely
non-discrimination rules. The requirement not to discriminate between firms
would then unambiguously increase investment incentives.
ENDS
Notes for Editors: ‘Unionisation Structures and Innovation Incentives’ by
Justus Haucap and Christian Wey is published in the March 2004 issue of the
Economic Journal.
Haucap is at Ruhr-University Bochum; Wey is at DIW Berlin, Technical
University of Berlin, and the Centre for Economic Policy Research.
For Further Information: contact RES Media Consultant Romesh Vaitilingam
on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com); or
the authors via email: Justus.Haucap@unibw-hamburg.de and cwey@diw.de