Effects of Centralisation on Investment

Capital is treated as constant or disregarded in most studies on centralisation of wage setting (in order to simplify the models). However, capital allocation may be of high importance in the long run (and dominate other short run effects). There are some rare studies in the literature. But they do not deliver unambiguous results.

66For a comprehensible presentation of the topic see Tirole (1995), chapter 7.

Static Models

Grout (1984) and Hoel (1990) show that capital allocation is distorted in local bargaining. The reason is that a high capital stock weakens the bar-gaining position of the firm by rising losses (opportunity costs of capital) during conflict. In centralised wage setting this effect does not arise since the investment decision of a single firm has no impact on wage setting of the central bargaining authorities (see also Hoel et al., 1993). The effect does, however, not imply higher investment in centralised bargaining since employment may be higher with local wage setting, and higher employment raises the productivity of capital. The only unambiguous effect of the model is that centralisation decreases investment per capita.

Dynamic Models

Moene & Wallerstein (1992) and Moene & Wallerstein (1997) investigate effects of centralisation in wage setting on investment in a vintage model.

In such models, productivity of capital (plant) depends only on the time of its installation (vintage). Productivity of an installed plant remains then constant until it is aborted. Nevertheless, plants may be closed down due to the availability of newer more productive capital. The number of newly installed and closed plants in one point of time depends on wages and is therefore endogenous: A plant is built if the required setup costs are less or equal to the expected (discounted) present value of profits. And in remains in operation as long as it delivers positive profits.

With decentralised bargaining, workers of plants with the same vintage obtain equal wages. Nevertheless a non-degenerate wage distribution results since plants with different vintage pay different wages. In contrast, a cen-tralised union sets equal wages for all workers, independent of plant age.

Though the details of the model are somewhat involved, it is intuitively clear that centralised wage setting yields a larger average productivity and lower average age of plants than the decentralised. The reason is that equal wages favour new installation of capital and put older plants out of business. The relative efficiency of centralised and decentralised wage setting depends on the share α ∈ [0,1] of the value added received by workers.⁶⁷ ( In order to concentrate on the central effects,αis assumed to be independent of the bar-gaining level.) The range ofαcan be divided in three (disjunkt) subintervals which characterise the relative efficiency of centralised and decentralised wage setting. If α is small enough, central wage setting is efficient. In the next interval above, centralised wage setting leads to lower employment, higher

67αin turn depends on bargaining power.

investment and higher output than decentralised wage setting. If α is close enough to unity, decentralised wage setting is efficient, i.e. yields higher em-ployment, investment and output. Without reference to the parameters of the model, no more specific prediction can be made.

Empirical Relevance

Moene & Wallerstein’s model fits neatly to stylised facts: capital equipment is higher and the capital stock is younger in economies with centralised labour markets. Also the empirical investigation of Hibbs & Locking (2000) suggest that the reduction of wage dispersion in the period 1963–1993 lead to higher productivity growth⁶⁸ However, the ambiguity of the results of Moene &

Wallerstein’s model do not allow a definitive assessment regarding relative efficiency. If one agrees to the common-sense opinion (which ist not backed up by clear evidence) that unions are strong in countries with highly centralised bargaining institutions and weak in the others, he has to conclude that the economic world is upside down with respect to bargaining institutions, and that the inferior institutional settings prevail. This admittedly na¨ıve conclu-sion points to a highly relevant aspect of the debate on centralisation: to the endogeneity problems, i.e. the question whether an to what extent central-isation of wage bargaining depends on the economic environment. We will come back to this issue below.

2.4.15 Centralisation and the Allocative Function of Wages in an Environment with Heterogenous Firms and/or Workers

Heterogeneity of Firms, Regions and Industries

A central argument against centralisation of wage setting rests on the fact that collective wage agreements put certain restrictions on wage differen-tiation between industries, firms and workers. According to this argu-ment, centralisation generates inefficiencies by ‘lumping together’ heteroge-nous firms (or sectors or regions) and workers. Let us consider two quota-tions from the literature which seem to be representative for several vari-eties of the argument. The first one, from the yearly report of the German Council of Economic Experts (Sachverst¨andigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung), stresses problems involved by hetero-geneity between firms, regions, and industries (sectors).

68A more detailed summary of the study will be given in section 2.5.5.

“In bargaining rounds – at least in the last ones – the tradi-tional convoy procedure [‘Geleitzugverfahren’] can be observed:

agreements are concluded in the strong pilot-regions of a branch, this bargaining outcome is then transferred – more or less – to other regions, and even then, if the economic conditions are sig-nificantly worse there, and unemployment is much higher. Fur-thermore, the agreement in one sector serves as an orientation for agreements in other sectors. Both, aggregate and regional un-employment are not accounted for sufficiently in the wage agree-ments.” Sachverst¨andigenrat (2003), §461, page 259 [translation by Johannes Ludsteck]⁶⁹

We will try to discuss the argument implicit in this quotation using two stylised theoretical models in sections 4.2 and 4.3. If these models capture relevant aspects of centralisation, we find no confirmation to this position, but ambiguous effects of centralisation on employment. Unfortunately, the quotation above does not state the relation between centralised and locally determined wages directly. The experts seem to suppose that the bargaining parties in the strong regions do not account for other regions, i.e. centralised bargaining parties in the strong regions behave as if they conducted purely local negotiations. If we assume – as it is done in the theoretical models in sections 4.2 and 4.3 – that bargaining is coordinated between regions, cen-tralisation produces lower wages for the strong regions as local negotiations did. With coordinated wage setting, gross employment effects may be pos-itive. Furthermore, it is difficult to find an obvious purely economic reason why rational local unions and employers from a weak region (or industry or firm) should adopt agreements from strong regions if this agreement did not – at least partially – account for its worse conditions.

Basically, there are four possible reasons. Firstly, expected costs of re-gional bargaining were too high to justify renegotiations or wage adjustment.

Secondly, union members are motivated by envy (see section 2.4.10 above) or loss aversion,⁷⁰ i.e. a relative wage significantly below unity would imply

69The original German text reads: “In den Tarifrunden – so in den letzten – kann das traditionelle Geleitzugverfahren beobachtet werden: In der oft wirtschaftlich starken Pilotregion einer Branche wird abgeschlossen, dieses Verhandlungsergebnis wird auf an-dere Tarifbezirke mehr oder weniger ¨ubertragen, und dies selbst dann, wenn dort die wirtschaftliche Basis deutlich schw¨acher und die Arbeitslosigkeit erheblich h¨oher ist. Zu-dem stellt der Abschluss in einem Sektor eine Orientierung f¨ur die Abschl¨usse in anderen Sektoren dar. Der Arbeitslosigkeit, sei es der gesamtwirtschaftlichen oder sei es der re-gionalen, wird in den Tarifabschl¨ussen zu wenig Rechnung getragen.”

70See Kahneman, Knetsch, & Thaler (1991). The loss aversion argument requires that workers from the inferior regions consider the wage in the high region as reference point.

a significant loss of utility due to utility interdependence. (Note that we had to account for transaction costs and utility implications of envy in an wel-fare comparison of bargaining structures if these two reasons were relevant.) Thirdly, unions do not account for the fate of unemployed workers. In this case, we have to explain why local unions put greater weight on utilities of the unemployed in decentralised bargaining. (The argument put forward by Hoel et al., 1993 claims just the opposite, see 2.4.16 below.) Fourthly, unions (and employers) might simply show herd behaviour, have too a high ‘preference’

for rules of thumb, or suffer from biased perception, i.e. forget low labour demand in their region when they hear about high wages in other regions.

By the way: Even if unions are not rational, employers can improve their fates, i.e. can get rid of general collective wage agreements by simply leaving the employers’ association and bargaining individually or founding another association (see Hagermeier et al. (1984), p. 84 and pp. 400-411). Even if we take irrational behaviour of unions for granted, it is unclear whether and why these anomalies should disappear in the transition to more decentralised bargaining. If perception bias does matter, decentralisation could improve things, since then wages might become more dispersed and loose their ‘focal point’ nature. Unfortunately, we found no explicit discussion of this inter-esting issue in the literature. If the ‘irrationality’ and ‘biased perception’

arguments were relevant, economists should try to discuss them in more de-tail (or consult psychologist) and search for conclusive evidence. Currently, these arguments seem to be used as gap-fillers –in face of missing empirical evidence.

By the way, the statement quoted above is not backed up by data or ref-erences to empirical studies. Even the attempt to retrieve the fuzzy remark

“that the agreement in one sector serves as an orientation for agreements in other sectors” in descriptive data is not successful. Lesch (2001) com-pares the growth rates of standard wages (‘Tarifl¨ohne’) between industries for the period 1991-1999. We find the private banking, insurance, and whole-sale branches at the bottom with 28.1, 28.8 and 33.4 percentage increases.

The ‘top ranks’ are occupied by the chemical industry, the textile indus-try, and metal- and electrical industry with 44.0, 48.9, and 61.0 percentage increases. (Yes, the losers had to be content with less than half of the win-ners’ increases.) Though it is really difficult to consider these differences as negligible, it remains – in face of lacking structural evidence – a matter of subjectivity to interpret them as too high or too low.

This seems a little bit heroic.

Downward Wage Rigidities An issue often stressed in the context of this debate concerns the question whether and to what extent centralised or de-centralised collective wage agreements are more flexible in the sense that they allow for (downward) wage adjustment to cyclical fluctuations. There exists now a considerable strand of empirical research on wage rigidity. Most con-tributions focus, however, exclusively on the existence and extent of nominal rigidities, but only some studies try to identify possible causes of rigidities.

Unfortunately, also the latter are related only loosely to the centralisation debate. At the theoretical level matters are complicated significantly by the fact that several reasons may be responsible for wage rigidity: collective wage agreements (long term contracts), implicit contracts, efficiency wage consid-erations, or insider-outsider aspects (see Campbell & Kamlani, 1997 for a survey). Even worse, these factors are not mutually exclusive but may com-plement and enforce one another. For example, efficiency wage problems may facilitate the foundation of a local union. Finally, even if it were possible to attribute wage rigidities precisely to the existence of collective wage agree-ments, this would be of less help since the rigidity is createdintentionally by the bargaining parties – at least if they are rational and bargain voluntarily as in Germany – and therefore may be an efficient arrangement.

Empirical studies follow two main approaches. The first one is simply to ask managers for the reasons why they resist to wage cuts in (more or less) representative surveys. The second one is to inspect large micro datasets and to compare the factual distribution of wages with a counterfactual one which would result if wages were flexible.

Let us start with the first approach. Such surveys were conducted (among others) by Akerlof & Yellen (1996) and Bewley (1998) for the USA, Agell &

Lundborg (1999) for Sweden, and Franz et al. (2000) for Germany.⁷¹ A com-parison of the results for Germany and the USA in Franz et al. (2000) suggests that rigidities due to collective wage agreements are somewhat more impor-tant for German managers than for their US colleagues. However, though the questionnaires contain identical items, the differences in the answers are likely to be caused by differences of the sampling procedure and a lack of representativeness in the US study. (The German survey is based on 801 answered questionnaires, the US on 185. Response rates for the surveys are 15.5% and 18.5%, respectively.)

Micro data studies (the second approach), e.g. Altonji & Devereux (1999) for the USA, Beissinger & Knoppik (2001), and Pfeiffer (2003) for Germany find significant nominal wage rigidities in Germany as well as in the de-centralised USA. However, Beissinger & Knoppik (2003) find no systematic

71For a listing of further studies see Beissinger & Knoppik (2003) and Pfeiffer (2003).

differences between Anglo-Saxon and continental European countries in a comparison of seven studies. Furthermore, even the results of studies relat-ing to the same country or dataset differ significantly and depend highly on the used estimation approach. For example, Beissinger & Knoppik find in an analysis based on a subsample of German social security data that 90%

of white collar and 70% of blue collar workers are protected against nomi-nal wage cuts. Pfeiffer, who does not differentiate between blue and white collar, finds (with the same dataset) that at most 60% of all workers are protected against nominal wage cuts. Surprisingly, Pfeiffer finds that higher sectoral wages have anegative effect on firm coverage, i.e. firms in industries which pay above-average wages have a lower probability to apply general collective wage agreements (see Pfeiffer, 2003, p. 203). Besides that, several methodological problems indicate that precision and stability of the results are insufficient for cross-country comparisons.

Franz & Pfeiffer (2001) appears to be the only study which tries to at-tribute reasons for nominal wage rigidity to the competing theories (collective bargaining, implicit contracts, efficiency wage considerations, and insider-outsider aspects) in an econometric analysis. They run several ordered pro-bit regressions which explain the managers’ agreement to statements on the reasons for rigidity by firm characteristics. For example, the agreement⁷² to the statement ‘Collective Wage agreements inhibit wage cuts’ is regressed on a dummy for membership in an employers’ association, on a dummy for the presence of a company collective agreement, a dummy on voluntary applica-tion of a general collective wage agreement, and several control variables.⁷³ Surprisingly, the coefficient of the company collective agreement dummy is significantly positive and even larger than the membership dummy, i.e. agree-ment of managers of firms with company collective agreeagree-ment is even more likely than that of managers of firms being members of an employers’ as-sociation. However, the difference between the two coefficients is highly insignificant. Besides that, the explanatory power of the probit regression is extremely poor: The pseudo-R² is 5.1%, placing the result under strong reservations. Franz & Pfeiffer conclude that collective wage agreements are more important reasons for wage ridigity (than the other theories mentioned above), since probit regressions relating to statements on other theories have even less explanatory power. We think, however, that also this conclusion is heroic in consideration of the vagueness of the concepts. From comparisons

72Agreement can be expressed in four degrees: ‘Not important’ (‘trifft nicht zu’), ‘of minor importance’ (‘trifft eher nicht zu’), ‘moderately important’ (‘trifft eher zu’), and

‘very important’ (‘trifft voll zu’).

73Control variables are industry dummies, a dummy on the presence of a work council, firm size dummies and a dummy indicating employee recruitment problems.

of separate answers for low, medium, and high qualified workers, they find that collective wage agreements are a more important obstacle to wage cuts for the low and medium qualified. This is, of course not surprising (and conveys little information) since the high qualified are hardly represented by unions.

To summarise, also a closer look at the empirical evidence on wage rigidi-ties delivers no clear answers.

Wage Differentials, Fluctuation and Structural Change

An argument, sometimes used implicitly in the literature, appeals to the function of wages as signals for structural change. According to this hy-pothesis, wage differentials provide incentives for workers to move from the less productive firms/industries to more productive ones. A related ques-tion concerns fluctuaques-tion of workers between firms in centralised and local bargaining.

Basically, the argument presupposes imperfect competition in the labour market, since wage differentials are eliminated instantaneously under perfect competition. Union wage policy, dictating equal wages in all firms/industries isin this sense⁷⁴equivalent to perfect competition. Though wage differentia-tion and wage compression (as implied by centralisadifferentia-tion of wage bargaining) may yield similar results, they do this by different mechanisms. Local wage setting ‘pulls’ workers from the less productive firms to more productive ones by higher wages, central wage setting ‘pushes’ them to the high productive ones, since the less productive firms are induced to fire workers while the more productive ones obtain opportunities to hire workers.

A significant difference between local and central wage setting exists only under imperfect competition in the labour market, for example due to fluctuation- or mobility costs or due to asymmetric information (regard-ing wages and work(regard-ing conditions). Then it is uncleara priori whether wage differentiation or wage compression is more suitable to eliminate productivity differentials.

A simple ad hoc comparison of the incentives gives no clear result. Cen-tral standard wages induce ‘bad’ firms to dismiss workers. The incentive to move to a ‘good’ firm amounts to the (utility) difference between the central wage⁷⁵ w_c and the unemployment benefit b,⁷⁶ formally u(w_c, m) −u(b,0).

74Of course, the wage level in a unionised labour market is different from the competitive solution. This is animportantdifference between true competition and union wage setting.

75Of course, our comparison had to be based on expected lifetime incomes instead of

‘wages’. We use the sloppy terminology because of its simplicity.

76More precisely,b should to be defined such that it covers the utility or disutility of

Respectively, the incentive to move in a local wage setting environment amounts to the difference between wages in ‘good’ (w_h) and ‘bad’ (w_l) firms u(w_h, m)− u(w_l,0). The relative size of the both differences is a priori unclear and depends heavily on the mark-up of wages over unemployment benefits. If it is large or workers dislike unemploymentper se, the push-effect of centralisation is more effective than thepull-effect of wage differentials.

The simple comparison of mobility incentives is misleading (or too sim-ple) in an important respect. Mainly, it does not account for the fact that wage setting affects labour demand of firms, i.e. that labour demand of the highly productive firms is lower with local than it were with centralised wage setting. Bertola & Rogerson (1997) construct a model with mobility costs where productivities of firms are subject to stochastic changes, and show that fluctuation increases unambiguously with centralisation (because of the wage adjustment argument). This result seems to be unambiguously in

The simple comparison of mobility incentives is misleading (or too sim-ple) in an important respect. Mainly, it does not account for the fact that wage setting affects labour demand of firms, i.e. that labour demand of the highly productive firms is lower with local than it were with centralised wage setting. Bertola & Rogerson (1997) construct a model with mobility costs where productivities of firms are subject to stochastic changes, and show that fluctuation increases unambiguously with centralisation (because of the wage adjustment argument). This result seems to be unambiguously in