Why Unions Reduce Wage Inequality: A Theory of Domino Effects*

• DOI: http://doi.org/10.1111/sjoe.12357
• Published date: 01 July 2020
• Date: 01 July 2020

Scand. J. of Economics 122(3), 1045–1072, 2020

DOI: 10.1111/sjoe.12357

Why Unions Reduce Wage Inequality: A

Theory of Domino Effects*

Johan Stennek

University of Gothenburg, SE-40530 Gothenburg, Sweden

johan.stennek@economics.gu.se

Abstract

Numerous empirical studies show that unions reduce wage differences. I demonstrate that their

motive might be a mix of fairness and strategy, maximizing the use of union bargaining power

in the presence of efficiency wages. Unions can push primarily for raising the lowest wages,

and still not sacrifice higher wages much, if the employers themselvesincrease higher wages to

protect efficiency-enhancing wage differences.If these “domino effects” are strong enough, then

an egalitarian wage policy might even increase the median wage.

Keywords: Collective negotiations; inequity aversion; minimum wages;ripple effects; strategic

commitment

JEL classification:J31; J51

I. Introduction

A large body of empirical literature suggests that unions increase wages

and reduce wage differences. They reduce wage differences associated with

skills, education, and tenure, both between and within firms and plants.1As

unions primarily raise the lower tail of the wage distribution,2the unions’

egalitarian preferences appear to reach far beyond the median member’s

immediate self-interest.

The Swedish Trade Union Confederation (Landsorganisationen i Sverige,

commonly known as LO) asserts that their motive for favoring their least

*I am grateful to Brigham Frandsen, Nils Gottfries, Ingemar G¨oransson,H˚akanLocking, Katarina

Richardson, Per Skedinger, Andreas Westermark, the referees, and seminar participants at the

universities of Antwerp, S¨odert¨orn, Gothenburg, Uppsala, Lund, Ume˚a, and Aarhus and at IFN,

SNEE, and the Swedish National Conference. This research wasfinanced by fakultetsmedel.

1The exactnumbers depend on the countr y,the time period and the methodology used. See reviews

by Freeman and Medoff (1984), Kaufman (2002), Blanchflower and Bryson (2004), and Card

et al. (2004). Recent studies, emphasizing causality, use a regression discontinuity design based

on union certification elections, and compare the outcomes in establishments where unions barely

won with those where unions barelylost. See DiNardo and Lee (2004), Lee and Mas (2009), and

Frandsen (2011).

2This feature was first noted by Freeman (1980). For a recent study based on a regression

discontinuity design, see Frandsen (2011).

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The editors of The Scandinavian Journal of Economics 2019.

1046 Why unions reduce wage inequality

productive members is a matter of fairness but partly also a matter of

strategy (Kommunal, 2003; LO, 2011a): “[e]ven if only a few people are

affected directly, increasing the lowest wages is absolutely decisive for the

wage level of the entire group.” A union report explains that increasing the

lowest wages causes a “domino effect”. If the unions manage to “push the

bottom”, they can rely on the employers to increase the wages of employees

who have ended up too close to the new lowest wage. Such domino effects

propagate through the entire wage distribution (Kommunal, 2004).

The Swedish Employers’ Confederation opposes the increase of the

lowest wages.3They argue that increasing the lowest wages increases

the total wage cost by more than the direct cost. If the lowest wages

are increased, then employers have to increase wages higher up in the

distribution. The purpose is to restore wage differences, in order to maintain

worker incentives and firm productivity (Meidner, 1974; Elvander, 1988).

Even if the unions’ and the employers’ descriptions appear to be

consistent, the details of the domino argument remain obscure. It is not

clear why the unions succeed in increasing the lowest wages by much, given

that the employers are aware of the domino effects and resist increasing the

lowest wages in proportion to the total increase in wage cost. It is also not

clear why the median workers would gain more from increasing the wages

at the bottom, relying on the domino effects, than from focusing the union’s

bargaining power on their own wages directly. This paper provides possible

answers to these questions.

The key to the domino mechanism is that wage differences enhance

firm productivity. A firm can increase its productivity by offering a wage

premium, for example, to those who invest in more education or to those

who volunteer for jobs with less desirable attributes, for example, in terms

of location, safety, and cleanliness.4If the union raises these wages by way

of negotiations, the employer need not offer any premium for efficiency

reasons. Union bargaining power is wasted. It might then be better for the

union majority to use their collective bargaining power primarily to raise

the lowest wages. Higher wages at the bottom spill over into higher wages

for those higher up in the wage distribution because employers voluntarily

3Theemployers list their opposition to increasing the lowest wagesfirst among its five top priorities

in the wage negotiations.

4As discussed below, wage differences can enhance productivity for several reasons. However,

some theories suggest the opposite – that within-firm wage differences can reduce firm

productivity (e.g., Akerlof and Yellen, 1988). Because the empirical literature shows that

employers prefer relatively large wage differences, it seems likely that the net effect of wage

differences on productiveefficiency is positive. There is also some more direct empirical evidence

that performance pay and wage inequality actually increase firm productivity (Lazear, 2000;

Bingley and Eriksson, 2001; Heyman, 2005; Lallemand et al., 2009; Gielen et al., 2010; Dohmen

and Falk, 2011).

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The editors of The Scandinavian Journal of Economics 2019.