Unions just cannot help it

The role of labor unions is to counteract the market power of oligopolistic employers. That is certainly beneficial, but by their very nature, unions have also a perverse effect. As they only represent their current members, they tend to keep employment lower than what would be optimal. Is this the only perverse effect?

Per Krusell and Leena Rudanko take a search and matching model and give unions their best shot: they also care about the unemployed and take into account the impact of their wage demands on job creation. If the union is able to commit on all future wages, we get the efficient outcome. However, if the union cannot commit, then unemployment will be higher than efficient. The reason is that the unions wants to extract rents from current matches. This optimal, time-inconsistent policy can have a substantial impact, three percentage points in unemployment (and GDP). Interestingly, the model also shows that real wage stickiness results form this lack of commitment, as well as excessive labor market volatility.