Unionization and Economic Performance: Evidence on Productivity, Profits, Investment, and Growth

Abstract The effect of labour unions on economic performance is a crucial factor in evaluating public policy Toward union organizing and bargaining rights. This paper evaluates theory and evidence on the relationship of unionization with respect to productivity, profitability, investment, and employment growth. The clear pattern that emerges from the research literature, primarily for the U.S. but also elsewhere, is that unions do not on average increase productivity and that collective bargaining is associated with lower profitability, decreased investment in physical capital and research and development (R&D), and lower rates of employment and sales growth. As long as unionized companies operate in a competitive environment, poor economic performance implies a continuing decline in membership, absent changes in labour law favourable toward union organizing. Yet deleterious union effects on performance tend to undermine rather than buttress the case for labour law reforms that increase union strength. Policies that enhance competition in product and factor markets promote economic growth and limit the costs associated with unionism, yet do little to facilitate the exercise of collective voice and employee participation in the workplace.

I. Introduction Central to policy debate regarding labour law reform and the appropriate role for labour unions in an economy is the effect of unionization on economic performance. There exists widespread support for a legal framework that permits the exercise of collective voice representing workers. The impact of unions on economic performance, however, bears heavily on the degree to which public policy should facilitate union organizing and bargaining power. There has been extensive study in recent years, particularly in the U.S., of the relationship of unionization to productivity, profitability, investment, and employment growth. The broad pattern that emerges from these studies is that unions significantly increase compensation for their members, but do not increase productivity sufficiently to offset the cost increases from higher compensation. As a result, unions are associated with lower profitability, decreased investment in physical capital and research and development (R&D), and lower rates of employment and sales growth. As long as unionized companies operate in a

competitive environment, weak economic performance in union firms relative to non union firms and sectors implies a continuing decline in membership, in the absence of changes in labour law favorable to union organizing. Yet the deleterious effects of unions on economic performance undermine rather than buttress the case for governmental regulations and policies that promote union strength. This paper examines the evidence on unions and economic performance. It presents, first, a simple economic framework for interpreting union effects on performance and examines briefly the difficult issue of measurement. It then examines the empirical evidence: studies of union effects on productivity, profits, investment, and growth. Emphasis is on outcomes in the United States, where this topic has been studied most extensively, although results from Canada, Britain, and elsewhere are briefly mentioned. Following a summary of the empirical evidence, the paper explores implications for public policy and labour law.

II. Unions and Economic Performance: A Framework for Analysis A useful starting point in our assessment of unions and performance is the framework popularized by Freeman and Medoff (1979, 1984), who contrast the "monopoly" and "collective voice" faces of unionism. Standard economic analysis emphasizes the monopoly face. Unions are viewed as distortin labor (and product) market outcomes as a result of increasing wages above competitive levels. Unions distort relative factor prices and factor usage (producing a deadweight welfare loss), cause losses in output through strikes, and lower productivity by union work rules and reduced management discretion. More recently, economists have emphasized unions' role in taxing returns on tangible and intangible capital, and examined empirically union effects on profitability, investment, and growth. It is this latter literature that is emphasized in what follows. In both the "old" and "new" literatures, union bargaining power or ability to extract gains for its members is determined primarily by the degree of competition or, more specifically, the economic constraints facing both the employer and union. The other, not necessarily incompatible, face of unions is what Freeman and Medoff refer to as "collective voice/institutional response." This view emphasizes the potential role that collective bargaining have in improving the functioning of internal labor markets. Specifically, legally protected unions may more effectively allow workers to express their preferences and exercise collective voice in the shaping of internal industrial relations policies. Union bargaining may be more effective than individual bargaining in overcoming workplace public-goods problems and attendant free-rider problems. As the workers' agent, unions facilitate the exercise of the workers right to free speech, acquire information, monitor employer behavior, and formalize the workplace governance structure in a way that better represents average workers, as opposed to workers who are more skilled and therefore more mobile or hired on contract from the outside. In some settings, the exercise of collective voice should be associated with higher workplace productivity, an outcome dependent not only on effective collective voice, but also on a constructive "institutional response" and a cooperative labor relations environment. The monopoly and collectivevoice faces of unionism operate sideby-side, with the importance of each being very much determined by the legal and economic environment in which unions and firms operate. For these reasons, an assessment of unions effects on economic performance hinges on empirical evidence. A useful starting point is to analyze union effects on performance when collective bargaining is introduced into what is otherwise a competitive environment. In the long run, profitability among firms in industries characterized by relatively easy entry of firms (e.g., perfect competition or monopolistic competition) tend toward a "normal" rate of return or zero economic profits (i.e., the opportunity costs of resources are just covered). Consider first a single unionized firm in what is otherwise a competitive industry with nonunion firms. The bargaining power of a union organized at a single firm (or more generally, a small portion of the industry) is severely limited unless it can help create value as well as tax returns. A union wage premium that is, higher compensation for a union worker than an otherwise identical worker in a nonunion firm must be offset by a productivity increase in order that costs do not increase and profits decrease. Note that in a competitive setting cost increases cannot be passed forward to consumers in the form of higher prices. So, in the absence of a productivity offset, unions should have little bargaining strength in a highly competitive industry. Substantial union wage increases in a competitive setting will lower profitability, investment, employment, output, and, consequently, union membership.The situation changes somewhat as we allow a relatively large

proportion of an industry to be unionized. In this situation, union wage increases (in the absence of increases in productivity) increase costs among many firms in the industry, so that no individual union firm is at a severe competitive disadvantage. In this case, costs can be more easily passed forward to consumers through price increases. But such a situation is difficult to sustain in the very long run, as long as entry and expansion of nonunion companies is relatively easy or the products produced are tradeable in the world market. In short, it is difficult for a union to acquire and sustain bargaining power and membership in a competitive, open-economy setting, in the absence of positive effects upon productivity that offset increases in compensation.Unions have considerably greater ability to organize, and to acquire and maintain wage gains and membership in less competitive economic settings. Such settings include oligopolistic industries in which entry is difficult owing to economies of scale or limited international competition, or regulated industries in which entry and rate competition is legally restricted. An example of the former includes the American motor vehicle industry prior to the influx of European and Japanese imports (and, more recently, of foreignowned nonunion assembly plants in the U.S.). Examples of the latter include the American motor carrier and airline industries prior to deregulation, as well as the current U.S. Postal Service (Hirsch 1993; Hirsch and Macpherson forthcoming; Hirsch and Macpherson 1996, Hirsch, Wachter, and Gillula 1997).If there is no offsetting productivity effect, a crucial question becomes the source from which union wage gains derive. Were it entirely a tax on monopoly profits, union rentseeking might be relatively benign. But in most economic settings, monopoly profits are relatively small or short-lived. What appear to be abnormally high profits often represent the reward to firms for developing newproducts,cost-reducing production processes, or simply the quasi-rents that represent the normal returns to prior investment in longlived physical and R&D capital. These profits serve an important economic role, providing incentive for investment and attracting resources into those economic activities most highly valued. To the extent that unions tax the quasi-rents from long-lived capital, union wage increases can be viewed as a tax on capital that lowers the net rate of return on investment. In response, union firms reduce investment in physical and innovative capital, leading to slower growth in sales and employment and shrinkage of the union sector (see Baldwin 1983; Grout 1984; Hirsch and Prasad 1995; and Addison and Chilton 1996). Although greatly over-simplified, the discussion above provides a reasonable framework for viewing the effect of unions on economic performance. Ultimately, empirical evidence is required to assess the relative importance of the monopoly and collective-voice faces of unionism. It is worth noting two points at the outset, however. First, the effects of unions on productivity and other aspects of performance may differ substantially across industries, time, and countries. This is hardly surprising given that both the collective-voice and monopoly activities of unions depend crucially on the labor relations and economic environment in which management and labor operate. Second, union effects are typically measured by differences in performance between union and nonunion firms or sectors. Such differences do not measure the effects of unions on aggregate or economy-wide economic performance as long as resources are free to move across sectors. For example, evidence presented below indicates that union companies in the U.S. have performed poorly relative to nonunion companies. To the extent that output and resources can shift between sectors, poor union performance has led to a shift of production and employment away fromunionized industries, firms, and plants and into the nonunion sector. Overall effects on economy-wide performance have been relatively minor. Most visible, of course, has been the rather precipitous decline inprivate sector unionism.What has been true for the U.S. since the 1980s, however, largely reflects the high degree ofcompetitiveness in the American economy, with the increasing importance of trade, deregulation of important industries, technological change that has reduced the use of production labor, relatively flexible labour market norms, and a economic and legal environment not overly amenable to union organizing and bargaining. The recent experience in the U.S. was not always the case, nor need it represent the current experience in other countries. The important point here is that the role of unions in society and the effects of unions upon performance are very much driven by the competitiveness of the environment in which firms and unions must operate. An obvious policy implication is that those concerned with economic performance should focus on policies affecting economic competitiveness and resource mobility in general and not only on the structure of labor law in which unions operate.

Profitability Union wage gains lower firm profitability unless offset by productivity enhancements in the workplace or higher prices in the product market. The evidence on productivity reviewed above indicates that unionization does not typically offset compensation increases. A rise in the price of the product sufficient to prevent a loss in profitability is possible only in a regulated industry where firms are "guaranteed" a competitive rate of return. In more competitive settings, where unionized firms compete with non union domestic companies and traded goods, there is little if any possibility of passing along increased cost via a rise in prices. Lower profitability will be reflected in decreased current earnings and measured rates of return on capital, and in a lower market valuation of the firm's assets.

Interpretation and Implications for Policy Knowledge about how unions affect economic performance is a prerequisite for intelligent debate about the appropriate role for labor law and for understanding the transformation taking place in the workplace and in relations between labor and management. For example, Weiler (1990) and others have argued that changes in National Labor Relations Boards interpretation of American labor law, the increased number of unfair labor practices filed and certified, and strategies adopted by management to avoid union organizing have seriously eroded workers' right to organize. Implicit (and sometimes explicit) in this analysis is the belief that the effects of unions in the workplace are largely benign. An alternative interpretation (see Flanagan 1987; Freeman and Kleiner 1990) is that increased resistance to unions by management and the increase in labor litigation reflect profit-maximizing on the part of the employers and are due in no small part to high wage premiums gained by unions rather than to changes in labor law or in their interpretation and enforcement. The evidence evaluated in this paper lends credence to the latter interpretation. Despite the very real benefits of collective voice for workers, the positive effects of unions have been overshadowed by union rent-seeking behavior. Productivity is not higher, on average, in union workplaces. The failure of collective bargaining to enhance productivity results in substantially lower profitability among unionized companies.Because unions appropriate not only a portion of monopoly-related profits but also the quasi-rents that make up the normal return to long-lived capital, unionized companies reduce investment in vulnerable forms of physical and innovative capital. Investment is further reduced since lower profits reduce the size of the internal pool from which investments are partly financed. Slower growth in capital is mirrored by slower growth in sales and employment (and, thus, union membership). The relatively poor performance of union companies gives credence to the proposition that the restructuring in industrial relations and increased resistance to union organizing have been predictable responses on the part of businesses to increased domestic and foreign competition. In the absence of a narrowing in the performance differences between unionized and nonunionized companies, modifications in labor law that substantially enhance union organizing and bargaining strength are likely to reduce economic competitiveness. Although the evidence indicates clearly that collective bargaining has led to a poor performance in unionized sectors, it is far more difficult to draw inferences about the effects of unions upon economy-wide performance. In fact, a highly competitive economy limits the costs unions can impose since resources flow to those sectors where they obtain the highest return. For example, lower capital investment or employment among unionized firms is in part offset by higher usage elsewhere in the economy. If resources could flow costlessly to alternative uses and if social rates of return were equivalent in no nunion sectors, unions would have little effect on economy-wide efficiency. Increases in unions power and rent-seeking would simply cause the relative size of the union sector to shrink. However, because unions have some degree of monopoly bargaining power, because the shifting of resources from union to nonunion environments occurs slowly, and because social rates of return differ across

investment paths, union distortions at the firm level necessarily translate into some degree of inefficiency economy-wide. Policy implications derive from the fact that an economy's competitiveness limits unions bargaining power and the economy-wide costs of unionism. Changes in labor law that severely restrict the rights and ability of unions to organize limit not only the monopoly power of unions but also reduce the benefits provided by a unions collective voice. If an economy or particular sector of an economy is sufficiently competitive, unionism's monopoly face is constrained. At the same time unions, if they are to prosper, must provide economic value added through an enhancement of worker voice and an improved labor relations environment. Those concerned about the economic costs associated with unions should lose sight neither of the potential benefits associated with the provision of an effective collective voice for workers nor the importance of policies that allow a high degree of domestic and international competition. Private sector unions that do not provide net benefits will not flourish in a competitive environment. The dramatic decline in private sector unionism in the U.S. as well as less rapid declines in Canada and Britain, can be interpreted in this light. It is important to note that the arguments above have rather less force in the public sector or publicly financed private sectors (e.g., health care in Canada). Here, competitive pressures play a far weaker role in limiting unions monopoly power. In the absence of competitive limitations on union power, labor law in such sectors must be designed not only to facilitate the exercise of collective voice, but also to limit unions' monopoly power. Ultimately, an evaluation of labor law and employment policies requires that we compare the current system to viable alternatives. In the U.S., the decline in private sector unionism to approximately 10 percent of wage and salary employees (Hirsch and Macpherson 1997) has taken place within a labor relations system all sides agree is overly contentious and marked by tremendous conflict. Indeed, there is no small degree of support both from labor and from management that the current legal structure surroundingcollective bargaining, which dates back to the National Labor Relations Act of 1935, is outmoded and in many ways inappropriate for the workplace of the 1990s. At the same time, nonunion labor relations has become overly litigious and subject to detailed regulation (e.g., laws against discrimination on the basis of age and disability, regulations governing workplace safety, and rules about pensions and benefits). Workers want both an effective collective voice in the workplace and a cooperative relationship with employers.9 Yet this combination of collective voice and cooperation has not been realized in many, if not most, union and nonunion workplaces. emerge. But, given the rather weak relationship between unionization and productivity, combined with strong resistance by management to union organizing, the possibilities for sizable, union-induced improvements in workplace productivity appear meager. It is likely, therefore, that we will see a continued decline in union coverage in the U.S. and elsewhere until the economy in each finds a new steady state at a lower but sustainable levels of union density.The outline of an ideal system of labor law and regulation lies well beyond the scope of this paper.Such a system, however, would be one that simultaneously offers workers many of the types of organizing rights and legal protections offered by current labor law, while at the same time allowing considerably greater flexibility and enhancing worker participation and cooperation at both union and non-union workplaces. That being said, it is difficult to be sanguine that such a system can evolve from current labor law or emerge in the current political or economic environment. The present system serves, on the one hand, as a less than ideal framework for a shrinking and rigid union labor relations system while, on the other hand, either restricting or doing little to facilitate a collective voice for workers in the mostly non-union private sector. Employment law and regulations should facilitate the development of worker participation and collective voice. At the same time, it is important that labor law not be replaced with a plethora of federal mandates dictating specific terms of employment. Workplace outcomes might better be determined by market forces and decentralized communications and bargaining in union and nonunion workplaces. References Abowd, John M. 1989. "The Effect of Wage Bargains on the Stock Market Value of the Firm," American Economic Review, 79 (September): 774-800.

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