Saturday, January 29, 2011

The death of Trade unionism

Trade unions have been a part of the labor market dating back to the 19th century. In this post, I am going to explain why I think their era might be over.

I will discuss three different factors, but first, I'd like to start with why trade unions exist and why they can actually be useful.

In essence, a trade union is a form of cartel - several "sellers" of labor join together and push up the price (salaries) above it's natural level - the level it would have in perfect competition. Perfect competition, for the uninformed, is a state where every seller and buyer is too small to affect the price: Prices equal marginal cost (the cost it takes to produce the last unit sold), and if a seller raises his/her price just 1 cent, he/she would lose all her customers. At the same time, no buyer can demand that prices be lowered; a buyer who wants to pay 1 cent less than the market price will find that no-one is willing to sell to that price. No-one has any pricing power in other words.

But if it is a cartel, doesn't that mean it should be banned outright? After all, aren't private cartels banned or harschly regulated? The problem of course, is that even if trade unions were banned, the market would still not be in a state of perfect competition. Why? Because there are too few buyers of labor (companies, that is). Perfect competition requires lots and lots of buyers AND sellers. If you only have a lot of sellers but very few buyers, you get something called Oligopsony - the opposite to Oligopoly (where the number of buyers are large but the sellers are few).

So, allowing the workers to form cartels (unions) may actually be better and fairer than not doing so. You may get closer to perfect competition by allowing trade unions - strange but true.

It may also be easier for a company to do salary negotiation with one or a few union representatives rather than discussing with every single worker - this goes in particular for companies with a high workers/managers ratio (if every worker is going to have the same questions, demands and suggestions, it saves a lot of time only having to hear and discuss them once with a representative from the union).

The different forms of competition

There are several forms of competition. Earlier, I mentioned the utopic state of Perfect competition which means that prices equal the cost associated with producing the last unit (marginal cost). However, how prices and output are determined is not exactly clear. In order for there to be perfect competition, goods must be homogenous - meaning they are virtually the same, so the only thing you can compete with is price.

There are several models for how firms set prices: One of them that I would like to discuss here is Bertrand competition. This model states that if there are more than 1 company, the price will equal marginal cost (so unless there's a monopoly, you'll have perfect competition). This model assumes that products are homogenous, so price is the only thing firms can compete with.

Explanation: Let's say there are two firms with the same costs, selling the same product - mineral water, for example. Both brands taste the same, so the only thing consumers think about is the price. If one bottle costs $5 and the other $4.90, they will pick the cheaper one. Let's say that marginal cost is $3. Firm 1 thinks like this: "I want to set the price at $5... but hey, if I do that, Firm 2 will just retaliate and set the price at $4.90, taking all my customers. So I'll set my price at $4.80, and since he's 10 cent more expensive than I am, I'll be able to take his entire market share... but then, he'll lower his price to $4.70 and I won't get any customers, so I'll have to lower mine to $4.60..."

And so on. The price will then fall to $3, which is the minimum price (below that, it would be more profitable not to produce the last unit at all).

Does the Labor market work like that? The left would have you believe that. Workers have to constantly lower their wages to keep up with the competition, and in the end, only the workers willing to work for a salary just high enough to keep starvation away will find a job. Workers with high costs (those that need to be able to afford expensive medications or those with large families) will be driven out of the market.

Labor unions is the equivalent to a cartel between our two mineral water manufacturers above. The manufacturers may co-operate, make a deal stating that none of them will sell for one cent below $5. Similarly, the trade unions may create a minimum wage - either by lobbying politicians to legislate or by all workers agreeing not to offer themselves to work at a salary below any given level. The workers are then not competing against each other anymore, just like our manufacturers above, and can force the price (salaries) up.

Of course, just like mineral water at $5 instead of $3 means that fewer bottles will be sold, the demand for labor will decrease and unemployment rise as salaries increase.

How the labor market really works

Of course, the leftist view of the labor market is overly simplified. They assume that the products (labor) is homogenous, so that everyone is equally good. That of course is not the case. Some workers are more efficient than others, and every worker has a skill set which sets them out from the crowd. In other words, workers don't have to compete with salaries - they can compete by offering unique skills as well.

So instead of competing with everyone else, you are only competing with those who have a comparable skill set. Employers today don't simply look for people who are able and willing to stand next to an assembly line, doing the same tasks every day for the rest of their lives. They are much more specific about what they want; some jobs require workers who can stand long hours, others require creativity, some require numerical skills and others even require charisma.

The fallacy of the leftist thinking is to treat workers as if they were all the same and had nothing to compete with except price (meaning to compete, they'd have to offer to work for low salaries). The fact of the matter is that just like almost all companies compete by offering things other than a low price - reliability, a luxury brand, durability etc, so does workers compete by offering things other than just cheap labor: Some are willing to work uncomfortable hours, others can offer a lot of academical skills (they may hold a university degree), some are really good at handling customers while others are great at working in a team.

Now we're going to introduce another term: Monopolistic competition. This is when a company has a "local" monopoly - for example, in a small town with only one clothes shop, that shop could be said to have a local monopoly on clothes. However, if they were to raise their prices a lot, people would certainly find it profitable to travel to a neighbouring town to get clothes - or another shop would open up in the small town.

You can also have a monopoly over a brand - Pepsi has a monopoly over their Pepsi brand and Pepsi cola, but if they were to double the price of Pepsi, almost all customers would switch to Coca-Cola. The same, of course, goes for Coca-Cola. Soft drinks are an industry with monopolistic competition. Prices will not be as high as they would with monopoly, but not as low as they would with perfect competition. The reason why Pepsi can sell their product at a price that is higher than the minimum price (marginal cost), is that some people are willing to pay extra to get that Pepsi taste. In short, many - probably most - customers are not indifferent between Pepsi and Coca-Cola. Some of them are willing to pay extra to get Coca-cola, while others gladly separate from their money to get Pepsi. However, the products are still so "close" that producers of Pepsi have to take the price of Coke into account, and the other way around.

In the same way, employers are not indifferent between workers. If they feel they have found a really good fit for a job, they are willing to pay more to get that specific worker. Workers can also have a "brand", just like companies - someone who is known for being a hard-working, honest man have an easier time getting hired and getting a raise than someone known for being a lying slacker. Someone with a good brand will get a higher salary than someone with a bad brand, just like companies with respectable brands can demand higher prices than those who do not.

Companies always seek to differentiate their products - they don't like Bertrand competition and will do pretty much anything to avoid it (although there are for sure several companies which compete with low prices). That is why we nowadays have plenty of different mineral waters in the shops; Mineral water was Bertrand's original example of an industry where you could only compete with price, because all kinds of mineral waters taste the same. Obviously, that has changed since he invented his model (you don't believe me, go check it out in your local grocery shop - that's monopolistic competition in action).

Just like companies seek to differentiate, so should workers. The problem is that many of them don't; they figure that since they are overall decent people, they deserve a job. That mentality - that job is something you have a right to have - is devastating for a person's chance to get a job. When enough people refuse to differentiate, the country they live in slowly loses its competitive advantage.

Another issue is barriers to entry (things that can stop potential buyers/sellers from entering a market - regulation, tariffs/quotas, licenses...). Many occupations require you to be certified, and you can't enter it just like that. Pharmacists, doctors, lawyers - all are examples of this. This limits the supply of labor and leads to higher prices.

Overall, the labor market is a lot closer to monopolistic competition than Bertrand competition. Every worker have a skill set that they have a monopoly over, but there are usually other workers with similar skill sets, so if a worker demands an outrageous salary, he/she will be replaced. While monopolies are regulated (at least in the western world), monopolistic competition is generally permitted. The reason is that monopolistic competition occurs because products are diversified and because consumers are willing to pay more to get a certain kind of product. To ban monopolistic competition would be the same thing as demanding that all products be homogenous - there would only be one kind of soft drink that both Pepsi and Coca-Cola would have to produce, and the one who could sell this one soft drink to the lowest price would then win. That would arguably lower our living standard, most of us considers a wide range of products to be preferable, even if that means higher prices. So even though monopolistic competition is inefficient (compared to perfect competition) economically, it is tolerated because even though it is not visible in the output and price equations, it leads to a higher consumer satisfaction than what would otherwise have been the case.

The same, of course, can be applied to the labor market.

I would also like to add that workers today tend to price discriminate, just like companies; they try to get paid the maximum amount they can and will demand a higher salary if they feel the company can pay more, and may accept a lower salary (rather than none at all) from an employer who they suspect cannot pay as much. This is also done by companies who offer student/retiree discount, or may offer a lower unit price if you buy in bulk. There is nothing inherently wrong with the practice, but it may partly explain why people with similar skills can have different salaries: They all try to squeeze their employers as much as possible, but how much money they get depend on how much their employers can afford. Monopolistic competition gives workers some market power, that is the ability to affect their wages. That is the case for most workers today.

This hasn't always been the case though. Back in the 19th century, almost all work was repititive and required very few skills. Also, all workers had gone to the same kinds of schools, spent the same numbers of years there, read the same books and so on. The labor market, in short, was not nearly as differentiated as now. Since you didn't have more skills than the guy next to you, and since your job didn't require any charisma, creativity or anything else (the assembly line won't move faster just because you're charmy), pretty much the only thing you could do if you didn't have a job and wanted one, was to offer to work for a lower salary than the ones that already had a job. They, in turn, would offer to work for an even lower salary to outcompete you, and you'd have to work for a salary even lower than that to keep your job.

Cartels are common when Bertrand competition occurs, but not so much during monopolistic competition. It is simply harder to co-operate and set a common price when products are diverse; a car from SAAB is simply not worth as much as one from Ferrari, and so they could not co-operate and set the same prices (or even set a minimum price which would be meaningless since Ferrari is not competing by offering a low price in the first place). The same of course goes for labor; everyone has a different lifestyle associated with different costs, and also different abilities, strengths and weaknesses. This might not have been so visible 150 years ago, but it certainly is today. Setting one salary for a certain type of workers at a workplace is therefore not suitable, and deciding where the minimum wage should be is very hard when living costs differ so much - the need for flexibility becomes greater by the day. In addition to that it should be mentioned that productivity (which is what really determines wage levels in the long run) today is so high that practically everyone can earn enough money to survive even if they can't work full time. In most European countries anyway, minimum wages are far above the "survival" level.

There are still jobs which are like that, but they are getting fewer and fewer. There are three main reasons:

1) Consumers constantly demand more. We want better and more complicated products all the time. Always striving to improve is in human nature I dare to say, but to produce these more and more complicated advanced products we need more and more skills and longer and longer education. This opens up for more opportunities to diversify and create your own profile on the labor market.

2) Globalisation. The repetitive, assembly line-style jobs can still be found, but nowadays mainly in China. The jobs that are left here in the western world require a much more diverse skill set. It should be noticed that unions, when they demand unjustified wage increases, are speeding up this process by making the cost of doing business higher which leads to more companies trying to cut costs by outsourcing.

The third reason I'd like to discuss more in detail:

Human Resource Management

The science of how to solve conflicts, negotiate and just in general how to treat workers is fairly new. Back in the 19th century, even we conservatives must concede that a lot of workers were treated badly and abused by their employers. This was largely because of lack of knowledge. Today, employers have understood that you actually lose money by treating your employees like animals. They become less efficient, and since a lot of jobs today require creativity and inspiration, doing things that will make your employees feel uninspired is the last thing you want to do. You cannot check whether they are doing their best; all you can do is pay them based on their result (commission, bonuses) and create a working environment where they can feel comfortable and inspired. See, workers don't strive to maximize their salaries - they strive to maximize utility (another word for satisfaction or happiness). Working means sacrificing utility, and the money that you get for it must be enough to make up for the utility you lose. This is the same thing as saying that working is not something we do for fun, and therefore we must be properly rewarded for it. How "un-fun" working is depends to a large extent on how you are treated on your workplace. If you feel that you are treated with respect, you may feel that you are only losing, let's say 5 "units" of utility/happiness. Then, your employer may only have to pay you $50 000 a year to make up for these 5 lost utility units. On the other hand, if you feel that every second at work is torture, you may feel that you are losing 10 units of utility, and so demand your employer pays you $100 000 instead (no, the value of every unit of utility is not constant, but just to simplify we are assuming that here). Whether or not your employer would agree to pay you that is a separate issue, but if he didn't, you would start looking for another job. It is said that compliments are free, but they are not only free - they can actually save money.

Trade unions have fought for better working conditions, a struggle which has in many cases been justified. Today though, almost all employers understand that you must show your workers some basic respect and treat them with decency. There are still employers who don't get this, but hardly so many that big unions can justify their existence.

With HRM, unions are less needed than they were before, and this contributes to their death.

Individualism - the dominating Zeitgeist

Lastly, the spirit of our times (in German called Zeitgeist) is unfavorable towards the trade unions. We have simply become more individualistic over time as we have gotten richer. This is of course a double-edged sword; I don't want to make it sound as if I do not see any trouble with this trend. But it is none the less a fact.

Trade unions encourage people to define themselves as a part of a collective, the Workers. They want them to think of the other workers as their friends, and the Capitalists (another collective) as their enemies. The class struggle is a cornerstone of unionism, and leftist politics as a whole. The problem, for them, is that fewer and fewer people are interested in being defined by where they work, if they work and how much they earn. What used to be a very important part of everyone's self-image (whether you were a carpenter, a factory worker or maybe even a business owner) is now of a lesser importance. People change jobs, they change industries, some may own a company and therefore be a capitalist for at some point in their life only to go back to being an employee later. We define ourselves more from other things such as whether or not we are good-looking, intellectual, what personality traits we have and so on. Whether this is a good trend or not I won't discuss tonight; there are certainly both positives and negatives associated with it. I am simply saying that it is an undeniable fact.

Today, magazines are full of guides telling people how to negotiate about their salary, how to write a resume that stands out and how to convince your boss to allow you to work flexible working hours, or to work from home. These things - working hours, salaries and so on are things the Trade union used to take care of. The trend is that people think they can do a better job than any union could do. And I happen to think they are right.

We also have empirical evidence of this: Young people in Sweden are considerably less likely to join the union (and considerably more likely to leave it) than their parents are. People in their 40's and 50's usually joined the union because everyone else did, and never really thought about why. Young people are more critical and individualistic and just in general don't like it when someone tries to tell them they can't negotiate their own salary.

Individualism doesn't fit well with unionism. As the old, traditional union members retire and die, membership in unions will decrease, in my view to the point where unions will become irrelevant.


To summarize, it is these factors which I believe will lead to an end for Trade unions, at least the way we know them - there will certainly still be a need for someone to educate people about how to do salary negotiations and maybe also solving conflicts, and while this doesn't necessarily have to be done by unions, that is the only role I can possibly see them have in the future. Unionism is dying a slow, painful death - painful for the leftists, many of whom rely on the unions for campaign contributions and the like. This is because we have moved from Bertrand competition to Monopolistic competition in the labor market, because

We need to remember that unions need a certain amount of members to be efficient. A union with only 1 % of all workers as members cannot function since it's so easy to find workers who are not unionized. There is a certain "critical mass", a percentage of the workforce which must be unionized for the unions to be able to achieve anything. Exactly how big this "mass" is can be discussed, but if the unions get too small, they will quickly disappear since the remaining members realize they are not getting any benefits anymore from their memberships. The point is that everyone doesn't have to leave the union; if maybe half the current members left, the effect would be the same as if everyone had left.

I know this post is unusually long and more resembles an essay. I am a student of Economics, which might explain it - I guess most of you had already figured that out.

I hope you enjoyed reading my thoughts on this issue. Please leave a comment.

John Gustavsson


BOSMAN said...

A reletive of mine is the leader of the electrician's union. They run their outfit a little differently than labor unions.

You are required to keep up in your skill through course work and training. Much of this done at their headquarters. Certain standards must be followed or you find yourself thrown out.

They have a strong apprentice program with strict rules and criteria.

He told me that their main goal is to keep the skill alive and of high quality.

That's why I don't look at these Unions in the same way as most labor unions who's goal is to create and save jobs. HIGH STANDARDS are not in most of their vocabularies.

These are the BUMS causing most of the problems in America.

John said...

I'm not trying to argue unions never have had any good effects. The problem is, as you say, that most of them are not like that. They are anti-technological nostalgics who can't understand the world has changed.

Anonymous said...

Most trade unions, you are earning based on your SKILL and demand for the skill.

The whiners in the labor unions want to earn the same money as those with a trade, to stand in a line and place one widget on top of another.


John said...

Notice: "trade unions" refer to all kinds of unions of workers who try to together raise their salaries (essentially acting like a cartel). I am not saying that the American Medical Association will cease to exist or something like that. There will always be barriers to entry to some occupations, and there should be.

I'm not sure about America, but in Sweden, seniority is what decided how much you were paid. Ie, if you had worked at your company for 10 years, you'd be paid more than someone who had worked for 5 (that is still usually the case, but nowadays your salary depends more on your actual results). The unions prefered this system to the one we have now, since all you had to do to get a raise was to stay at the same firm.