Wage Formation in a Two-sector Open Economy with Two Strong Unions
This chapter focuses on a two-sector model describing a small open economy with trade unions able to set nominal wages. The wage formations are interdependent in the sense that the optimal wage for one union depends on the outcome of the other sector. This interdependence takes place through demand for labour, the overall price level and ‘relative wage effects’.
Two different equilibria, the non-cooperative (Nash) equilibrium and a ‘leader-follower’ equilibrium, are studied and compared. The latter involves lower wages and higher employment compared with the non-cooperative equilibrium.
The importance of aggregate demand, traded sector prices and productivity are outlined. Comparative static predictions depend crucially on the unions’ utility functions.
Implications of ‘relative wage focusing’ are discussed. The wage levels increase as unions attach more importance to relative wages. But the effect on wage changes, due to changing aggregate demand, prices and productivity is ambiguous.
KeywordsWage Rate Trade Union Real Wage Labour Demand Aggregate Demand
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