Are labor unions consistent with the assumptions of perfect competition?

Author:Reardon, Jack

The percentage of U.S. workers organized by a labor union has steadily declined from a peak of 35 percent in 1954 to 12.9 percent today (U.S. Bureau of Labor Statistics 2005). Institutionalists have suggested policies to revitalize the labor movement, (1) but such a task is difficult in today's ideological climate in which "a united front seeks to impose the discipline of the market" (Jennings 2004, 142).

In order to restore labor's strength, effective policy must resonate with "the nation's commitment to individualism, self-reliance, and economic freedom" (Toruno 2004, 281). A formidable ideological obstacle, however, is the perfectly competitive model (PCM) under which resources are efficiently allocated as if by an invisible hand, without need for institutional intervention.

The PCM resonates with "the image of a social order dominated by self-reliant individuals carrying on economic activity without the need for government oversight" (Toruno 2004, 274). The PCM is praised as an "intellectual triumph" (Lipsey et al. 1999, 288) under which "things do not get any better" (Boyes and Melvin 2005, 583). Since a labor union within the PCM is superfluous and can only distort market outcomes, it "represents a wrench in an otherwise mellifluously running machine, an unsightly weed to be extirpated" (Woodbury 1987, 1786). The PCM also forms the basis of the so-called monopoly face of labor unions whereby unions are believed to "raise wages above competitive levels [causing] harmful economic effects" (Freeman and Medoff 1984, 6).

Despite voluminous criticism of the PCM and its assumptions, (2) orthodox economists believe that given the PCM assumptions, deductive logic proves that resources are efficiently allocated without need for institutional intervention. But is this true? Is this conclusion logically deductible from its assumptions?

The purpose of this paper is to demonstrate that this conclusion cannot be derived from the PCM assumptions without making ex post facto violations. Correction of the logical errors, in fact, leads to the opposite conclusion that resources within the PCM cannot be allocated efficiently without institutional intervention and that a labor union can efficiently allocate resources within the PCM. So rather than inhibiting individualism, self-reliance, and economic freedom, labor unions enable individuals to operationalize these values within the PCM.

This paper will focus on perfect competition in the labor market and will critique the PCM from within this model. The first section will critique the logical errors of the PCM; the second will offer a revised argument; and the third will discuss the implication of these findings.

Logical Errors in the Perfectly Competitive Model

This section will accept all PCM assumptions as true as well as the narrow neoclassical view of efficiency in order to demonstrate the logical flaws in the PCM. (3) Once corrected, the next section will prove that the PCM cannot allocate efficiently resources on its own without institutional intervention.

To sharpen our argument, let us focus on firm A, a representative firm in industry X, which is assumed to operate ill a perfectly competitive labor market. For ease of exposition we assume this firm also operates in a perfectly competitive product market, which allows market price to be constant, so that the marginal revenue product (MRP) equals the value of the marginal product (VMP), defined as the extra dollar value in output obtained from an extra unit of labor. (4)

The labor demand curve of firm A, illustrated in figure 1, is downsloping and equals the MRP. The firm's labor supply curve is perfectly elastic at the industry wage, We, and also equals its marginal wage cost (MWC), defined as the absolute change in the total wage cost resulting from the employment of an additional unit of labor. Firm A will maximize its profits by hiring Qe units of labor, where MRP = MWC. To the left of Qe, the MRP exceeds the MWC, inducing the firm to hire more labor. To the right of Qe, the MWC exceeds the MRP, inducing the firm to reduce its units of labor.


Since firm A can obtain all the workers it wants at We, it has no incentive to offer a higher wage. If, however, firm A offers a lower wage, it will not attract any labor because each worker has an opportunity cost of at least We and can find employment elsewhere. Specifically, since "the labor market [is] free of barriers to entry ... workers are free to change jobs or move to labor markets that pay higher wages, if they wish to do so" (Ayers and Collinge 2004, 513).

Ease of exit, it is assumed, protects workers in the PCM because, "if a worker is dissatisfied with a job, he or she can quit and find a better one" (Reynolds et al. 1998, 407). Ease of exit/entry is the cornerstone of the PCM (Prasch 2004, 148). It is clear why exit is preferred to other corrective mechanisms such as voice:

[Exit] is neat--one either exits or one does not; it is impersonal

... and it is indirect--any recovery on the part of the declining

firm comes by courtesy of the Invisible Hand as an unintended by-product ... [whereas] voice is just the opposite of exit. It is ... far more "messy." ... [I]t implies articulation of one's critical opinions.... [It] is direct and straightforward rather than roundabout. (Hirschman 1970, 16-17)

Given costless mobility, it is assumed that if a wage less than We is offered, all affected workers will exit, creating a shortage of workers which will return the wage to We. By ensuring that all dissatisfied workers exit, efficiency is achieved by the market's invisible hand, rendering institutional intervention superfluous since "workers who have a legitimate dissatisfaction or grievance have a readily available and low (zero) cost means to solve the problem--quit and find a job elsewhere "(Kaufman 2004b, 360). Thus, according to orthodoxy, there is no need for institutional intervention within the PCM which will only generate inefficiencies. Specifically, a higher union wage will force unionized firms to substitute capital for labor, thus creating unemployment. (5)

The perfectly competitive model arrives at its conclusion by imposing ex post facto restrictions on three assumptions of the PCM: exogenous preferences, rationality, and profit maximization, each of which will now be explained.

The assumption of exogenous preferences is integral to the PCM because it purports to demonstrate that individuals acting alone, free from coercion, will gravitate toward an efficient outcome: "Tastes are...

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