Economic models of union behaviour generally predict some degree of real wage rigidity in response to shifting labour demand, but are more or less silent on the effect of risk and external uncertainty on wage determination. In Discussion Paper No. 1232, Research Fellow Michael Burda investigates the idea that, in addition to their effects on wage levels, monopoly unions provide `wage insurance' to their members. By wage insurance it is meant the smoothing out of diversifiable (insurable) income risk over states of the world, which under market clearing may be variable.

Risk-averse workers will generally be willing to purchase insurance, or to sacrifice some expected wage for reduced variance. To the extent that the market cannot provide it, a union could offer it to its members in the form of a less variable wage profile over time, space, and events. An optimal union contract is characterized by real wage and other types of flexibility only in response to systematic changes in underlying uncertainty. Under such conditions, there is no presumption that the `union wage premium' relative to the free market wage is positive. The author models the effect of unemployment benefits, average productivity, and risk on the desirability of union membership, and offers an economic interpretation of equity and solidarity in union policy. The model can also explain the negative correlation between inequality and unionism in developed countries.

Unions and Wage Insurance
Michael C Burda

Discussion Paper No. 1232, August 1995 (HR)