Germany is country characterized by a high coverage of collective agreements and by high and persistent unemployment. The strong unions are by many perceived to contribute to the unemployment problem. In recent years the German government has introduced several labor market reforms to fight the poor performance of the labor market. One of these measures involved a replacement scheme with a reduction of benefit entitlements to the unemployed. According to theory a cut in unemployment benefits reduces unemployment by making workers less selective to job offerings. In this thesis I consider the indirect effect on unemployment from the cut in unemployment benefits when the wage bargaining regime is endogenous. By analyzing the theoretical linkage between unemployment benefits and the setting of the bargaining process between firm and workers, I examine if a change in unemployment benefits potentially changes the bargaining system itself. To illustrate the importance of wage bargaining settings, I take advantage of a search and matching model with endogenous union formation as presented in the paper: ”Product Market Regulation and Endogenous Union Formation” by Ebell and Haefke (2006). This model is a dynamic general equilibrium model which combines monopolistic competition in the goods market with unemployment arising from Mortensen-Pissarides-style matching frictions. What separates this model from the standard search and matching models is the workers opportunity to collectively decide on the type of bargaining process in each firm, making union formation an endogenous factor of the model. To simplify, I separate between two alternative wage bargaining settings: Collective and individual bargaining. Under collective bargaining the coalition of workers negotiates with the firm together, in a process where they negotiate both over the wage and the number of workers, whereas under individual bargaining the firm treats each worker as a marginal worker and negotiate the wage with each worker pair wise.
The main contribution of the analysis is a simulation of the search and matching model, where I carry out a policy experiment by simulating the general equilibrium response for several degrees of unemployment compensation. As Germany is a country where the majority of workers are covered by union wage contracts, I calibrate the collective bargaining version of the model to match stylized labor market data. Using the same baseline values obtained from the calibration, I compare the labor market response of each bargaining regime by simulating both bargaining versions of the model. Taking account of the government’s budget constraint and the monopolistic behavior of the firm, the simulation provides more than a partial analysis of the labor market by illustrating the long-run equilibrium response in all key variable of the model.
The policy experiment shows that the choice of bargaining regime is crucial for the size of the equilibrium response from a lasting change in unemployment benefits: In the collective bargaining economy an increase in unemployment compensation is met by a strikingly stronger response in steady state unemployment and after-tax wages compared to the individual bargaining economy. This follows from the collective bargaining process, which secures an efficient adjustment of the firm and an even distribution of the cost of increased wage demand between firms and workers. In the individual bargaining economy firms choose employment freely, and as the firm considers each worker on the margin the worker surplus reflects the marginal value of the worker to the firm. As the workers’ value decrease in employment, individual bargaining firms choose to overhire to depress wages and thereby secure a larger share of the total surplus from production. This leads to a relatively modest increase in unemployment with the degree of unemployment compensation in the individual bargaining economy. On the other hand, the model simulation suggests that the cost from overhiring is a considerably reduced surplus for individual bargaining workers for all degrees of unemployment compensation.
In the final contribution of the thesis, I examine if a lasting change in unemployment benefits actually affects the setting of the bargaining system itself. Letting the choice of bargaining process for each firm be an endogenous factor of the model, I check numerically for both bargaining economies the necessary conditions for a symmetric Nash equilibrium. The result from the policy experiment is clear: Even though the individual bargaining economy shows a weaker response in steady state unemployment for high levels of unemployment benefits, the workers in the model choose to form bargaining coalitions for all levels of unemployment compensation. As the choice of bargaining institution is only a choice of the working part of the economy, collective bargaining is preferred as it secures a higher surplus from employment.
The paper is organized as follows: Section 1 introduces relevant literature on unemployment insurance and search and matching frameworks. Further I describe the problem of the thesis and how I proceed to solve it by simulating the wage bargaining model and carry out the policy experiment. Section 2 presents the basic model and outlines the implications on key factors in the economy with respect to a lasting change in the level of unemployment benefits. Section 3 follows with the determination of general equilibrium and introduces the free entry condition, thus making the degree of product market competition an endogenous variable in the long-run version of the model. Further I discuss why the model does not necessarily lead to an efficient allocation of search intensity. Section 4 gives a short analysis of bargaining institution stability and how it relates to employment, worker’s surplus and wages. Section 5 explains the calibration of the model to German long run data and summarizes the main results of the policy experiment. Finally, section 6 concludes and summarizes important findings from the model and how they relate to the German labor market.