Wednesday, 25 September 2013

The free market is not perfect: The case for unions

It has been a while but I thought I would return to one of my pet series of posts which attempts to provide a rational economic explanation for much of what we see around us.  Most people have a basic understanding of economics 101 however this is not enough.

There are those, especially on the political right who advocate the free market as the solution to all our problems.  The believe that market mechanisms are the most effective and efficient means of allocating resources and to the largest extent possible governments should keep out of this.  I believe this to be only partially true.  As I have posted about before, better outcomes often result if governments are around to enforce property rights and intellectual property rights which lead to innovation and better outcomes for society which would not result in a free market.

This time, I am going to stretch the bow a little further (and perhaps drive those free market advocates a little crazy).  I believe that unions are a product of the free market and rational actors and are a natural part of an economy where businesses are allowed to gain market power.

A union is a worker trying to improve their outcomes through scale

All of intuitively understand that the bigger an enterprise gets, the lower it's unit cost of production is.  This is one of the major benefits of scale.  However there are other benefits - if it is able to achieve some form of market power then it can influence pricing and extract monopoly rents from customers.

Unions are rational workers doing exactly the same thing.  They are achieving market power to deal with companies on a more even footing.  The negotiating position of an individual is minimal - you take what you are given (especially if you are replaceable), however the negotiating position of a workforce is formidable - a company cannot fire everybody if they want things made.  Just as the company would seek to extract monopoly rents if they are in a position to exercise market power, so are unions able to extract higher than market outcomes for their members if they have enough power in the system.

This is no better and no worse than the company making the money themselves.  There is often a rhetoric which suggests that it is good for companies to make large profits and it is bad for unions to demand a large share of the profitability of the company.  I do not view one outcome as
necessarily better or worse for the system - it is just where the profits in the system are going - do they flow to the owner of the infrastructure / business (i.e. the shareholders) or do they flow to the employees?

Unions are necessary where an employer has market power over their employees

In a competitive labour market, unions have much less influence or relevance.  You will often see union membership drop when times are good because if employees are not getting paid enough or are being treated badly then they will move elsewhere and so companies compete to retain their employees.

When times are bad or where the employer has a monopoly in the jobs in that particular market, then unions have a massive role to play.  The best example is teachers.  In most cities there are only a few employers of teachers.  Although there will be many schools, the employers are basically the State and a few major religious institutions (e.g. the Catholic Church for the Catholic school system).  A worker who is being paid an insufficient amount of money or being treated badly by the State cannot easily find another employer who will pay them more or give them more benefits.  Their only choice is to stay and deal with the same employer.

However, because this employer has so much market power over the employee they can tell the employee to take a hike if they want to.  This is where unions come in - the state can tell one teacher to take a hike if they want more pay...but they can't tell ALL teachers to do so.

Indeed in such a system it is almost necessary for employees to unionise.  Indeed it is economically rational for them to do so.

This does not mean that I agree with all the tactics that unions use...

Although I have outlined above the economic rationale for unions, it does not mean that I agree with or approve of their tactics.  They rely on having control over the whole system of employees which means they often use bullying tactics to get people to join to increase their market power.

Further where they are dealing with small companies who have no real power over their employees they become the ones with market power who can make or break small companies.  This leads to inefficient outcomes.

Unions are not a product of an efficient market...but they are necessary in an inefficient market

Unions are not the product of an efficient market.  Indeed the more competition there is for labour the less relevant they are.  However the fact is that there are many industries which are inefficient and have market power.  There are monopolies which are created through the granting of property rights and to balance this up we need to allow and support unions in the right circumstances.

There should be an equal balance of power between employers and employees so that neither takes advantage of the other and so that the most competitive outcomes result.

Do you disagree?  Do you think unions have no place?  I would love to hear your opinion so please post below

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