Unionization and Economic Performance: Evidence on Productivity, Profits, Investment, and Growth
PUBLIC POLICY SOURCES NO. 3

Barry T. Hirsch
Professor of Economics, Florida State University

CONTENTS

Introduction
Unionization and Economic Performance
A Framework for Analysis
Measurement
Evidence: Unions' Effects on Productivity, Profits, Investment, and Growth
References
About the Author

Do labour unions advance or hinder the economic performance of firms and the competitiveness of the economy? The answer to this question has significant implications for public policy and the design of labour law. Specifically, the answer to this question provides us with a rationale for either strengthening or weakening labour legislation governing bargaining rights and the organizing of unions. To answer this question, Professor Barry T. Hirsch surveys the evidence from research into the effects of unionization on productivity, profitability, investment, and employment growth.

Professor Hirsch surveys the literature on unionization and economic performance-mostly from the United States but also from Canada, Japan, and Britain-and concludes that, on balance, the effects of unions upon productivity and productivity growth are small; they do not offset the cost increase resulting from higher union wages. The evidence presented in his paper clearly indicates that unionization leads to lower profitability. Indeed, whether one studies the impact of unions on profitability at the level of the industry, the firm, or the line of business, unionized firms have profits that are 10 percent to 20 percent lower than the profits of non-union firms. Further, the evidence from Britain also suggests that closed-shop unions have a stronger negative impact on profitability.

Recent research also shows that union monopolies reduce investment in physical capital and in research and development (R&D) and other forms of innovative activity. In a study conducted by Professor Hirsch of 500 publicly traded American manufacturing firms, the capital investment of an average unionized firm was 6 percent lower than that of a comparable nonunion firm. Hirsch also found that the average unionized firm made 15 percent lower annual expenditure on R&D. A forthcoming Canadian study using aggregate data also finds that unions reduce investment in physical capital by a significant margin.

It is not surprising, given higher wages and lower levels of profitability and investment in unionized firms, that employment growth is markedly lower as well. Studies from Canada, the United States, and Britain on the effects of unionization upon employment show the negative impact of unionization upon employment growth. In the case of Canada, a study conducted in 1993 by Professor Richard Long confirms the international evidence. This study examined the performance of 510 manufacturing firms during the period from 1980 to 1985 and found that the median growth rate of non-union firms during this period was 27 percent while the growth rate of unionized firms was zero. After making adjustments in his analysis to account for the fact that unionized firms tend to be larger than non-unionized firms and found in declining industries, he concluded that unionized manufacturing firms grew 3.7 percent slower than comparable non-unionized firms; and unionized firms in the non-manufacturing sector grew 3.9 percent slower than their non-union counterparts.

In sum, the evidence from research indicates that unions tend to increase wages but not productivity, reduce profitability, reduce investment in physical capital and R&D, and, most importantly, lower the rate of employment growth.

Professor Hirsch does not specifically address Canadian issues in labour law. Current federal and provincial labour codes in Canada make provision for exclusive representation. In practice, this means that unions with sufficient worker support have a legal monopoly granted to them. In addition, under most provincial labour codes, it is relatively easy to unionize a place of work; hence there is a higher rate of unionization in Canada than in the United States.

On the basis of the comprehensive evidence presented in this paper, it is imperative that as a matter of public policy we liberalize provincial and federal labour laws so as to lessen the rigidities that characterize the Canadian labour market and cause its negative impact upon economic prosperity. In other words, as the author of this study puts it: "Workplace outcomes would be better determined by market forces and decentralized communications and bargaining in union and non-union workplaces." In the final analysis, reform of the labour market and competitive product markets are critical to neutralizing the adverse effects from union bargaining power. A higher standard of living for Canadian workers is best achieved by creating a competitive economy and through enhanced productivity growth and not by protecting the monopoly power of labour unions.

Professor Hirsch has worked independently of The Fraser Institute. His conclusions and work do not necessarily reflect the views of The Fraser Institute and its directors. The Institute does, however, welcome his contribution and hopes that it will shed light on this important topic. Public responses to this document should be addressed to Fazil Mihlar at The Fraser Institute.

-Fazil Mihlar

Central to policy debate regarding labour law reform and the appropriate role for labour unions in an economy is the effect of unionization on economic performance. There exists widespread support for a legal framework that permits the exercise of a collective voice representing workers. The impact of unions on economic performance, however, bears heavily on the degree to which public policy should facilitate union organizing and bargaining power. There has been extensive study in recent years, particularly in the United States, of the relationship of unionization to productivity, profitability, investment, and employment growth. The broad pattern that emerges from these studies is that unions significantly increase compensation for their members but do not increase productivity sufficiently to offset the cost increases from higher compensation. As a result, unions are associated with lower profitability, decreased investment in physical capital and research and development (R&D), and lower rates of employment and sales growth. As long as unionized companies operate in a competitive environment, weak economic performance in union firms relative to nonunion firms and sectors implies a continuing decline in membership, in the absence of changes in labour law favourable to union organizing. Yet the deleterious effects of unions on economic performance undermine rather than buttress the case for governmental regulations and policies that promote union strength.

This Public Policy Source examines the evidence on unions and economic performance. It presents, first, a simple economic framework for interpreting union effects on performance and examines briefly the difficult issue of measurement. It then examines the empirical evidence: studies of union effects on productivity, profits, investment, and growth. Emphasis is on outcomes in the United States, where this topic has been studied most extensively, although results from Canada, Britain, and elsewhere are briefly mentioned. Following a summary of the empirical evidence, the paper explores implications for public policy and labour law.

A useful starting point in our assessment of unions and performance is the framework popularized by Freeman and Medoff (1979, 1984), who contrast the "monopoly" and "collective-voice" faces of unionism. Standard economic analysis emphasizes the monopoly face. Unions are viewed as distorting labour (and product) market outcomes by increasing wages above competitive levels. Unions distort relative factor prices and factor usage (producing a deadweight welfare loss), cause losses in output through strikes, and lower productivity by union work rules and reduced management discretion. More recently, economists have emphasized unions' role in taxing returns on tangible and intangible capital, and examined empirically union effects on profitability, investment, and growth. It is this latter literature that is emphasized in what follows. In both the "old" and "new" literatures, union bargaining power or ability to extract gains for its members is determined primarily by the degree of competition or, more specifically, the economic constraints facing both the employer and union.

The other, not necessarily incompatible, face of unions is what Freeman and Medoff refer to as "collective voice/institutional response." This view emphasizes the potential role that collective bargaining have in improving the functioning of internal labour markets. Specifically, legally protected unions may more effectively allow workers to express their preferences and exercise "collective voice" in the shaping of internal industrial relations policies. Union bargaining may be more effective than individual bargaining in overcoming workplace public-goods problems and attendant free-rider problems. As the workers' agent, unions facilitate the exercise of the workers' right to free speech, acquire information, monitor employer behaviour, and formalize the workplace governance structure in a way that better represents average workers, as opposed to workers who are more skilled and therefore more mobile or hired on contract from the outside the plant. In some settings, the exercise of collective voice should be associated with higher workplace productivity, an outcome dependent not only on effective collective voice but also on a constructive "institutional response" and a cooperative labour-relations environment. The "monopoly" and "collective-voice" faces of unionism operate side-by-side, with the importance of each being very much determined by the legal and economic environment in which unions and firms operate. For these reasons, an assessment of unions' effects on economic performance hinges on empirical evidence.

Let us begin with an analysis of unions' effects on performance when collective bargaining is introduced into what is otherwise a competitive environment. In the long run, profitability among firms in industries characterized by relatively easy entry of firms (e.g., perfect competition or monopolistic competition) tend toward a "normal" rate of return or zero economic profits (i.e., the opportunity costs of resources are just covered). Consider first a single unionized firm in what is otherwise a competitive industry with nonunion firms. The bargaining power of a union organized at a single firm (or more generally, a small portion of the industry) is severely limited unless it can help create value as well as tax returns. A union wage premium-that is, higher compensation for a union worker than an otherwise identical worker in a nonunion firm-must be offset by a productivity increase in order that costs do not increase and profits decrease. Note that in a competitive setting cost increases cannot be passed forward to consumers in the form of higher prices. So, in the absence of a productivity offset, unions should have little bargaining strength in a highly competitive industry. Substantial union wage increases in a competitive setting will lower profitability, investment, employment, output, and, consequently, union membership.

The situation changes somewhat as we allow a relatively large proportion of an industry to be unionized. In this situation, union wage increases (in the absence of increases in productivity) increase costs among many firms in the industry, so that no individual union firm is at a severe competitive disadvantage. In this case, costs can be more easily passed forward to consumers through price increases. But such a situation is difficult to sustain in the very long run, as long as entry and expansion of nonunion companies is relatively easy or the products produced are tradeable in the world market. In short, it is difficult for a union to acquire and sustain bargaining power and membership in a competitive, open-economy setting, in the absence of positive effects upon productivity that offset increases in compensation.

Unions have considerably greater ability to organize and to acquire and maintain wage gains and membership in less competitive economic settings. Such settings include oligopolistic industries in which entry is difficult owing to economies of scale or limited international competition, or regulated industries in which entry and rate competition is legally restricted. An example of the former includes the American motor vehicle industry prior to the influx of European and Japanese imports (and, more recently, of foreign-owned nonunion assembly plants in the United States). Examples of the latter include the American motor carrier and airline industries prior to deregulation, as well as the current United States Postal Service (Hirsch 1993; Hirsch and Macpherson forthcoming; Hirsch and Macpherson 1996; Hirsch, Wachter, and Gillula 1997).

If there is no offsetting productivity effect, a crucial question becomes the source from which union wage gains derive. Were it entirely a tax on monopoly profits, union rent-seeking might be relatively benign. But in most economic settings, monopoly profits are relatively small or short-lived. What appear to be abnormally high profits often represent the reward to firms for developing new products or for introducing cost-reducing production processes, or simply the quasi-rents that represent the normal returns to prior investment in long-lived physical and R&D capital. These profits serve an important economic role, providing incentive for investment and attracting resources into those economic activities most highly valued. To the extent that unions tax the quasi-rents from long-lived capital, union wage increases can be viewed as a tax on capital that lowers the net rate of return on investment. In response, union firms reduce investment in physical and innovative capital, leading to slower growth in sales and employment and a shrinkage of the union sector (see Baldwin 1983; Grout 1984; Hirsch and Prasad 1995; Addison and Chilton 1996).

Although greatly over-simplified, the discussion above provides a reasonable framework for viewing the effect of unions on economic performance. Ultimately, empirical evidence is required to assess the relative importance of the monopoly and collective-voice faces of unionism. It is worth noting two points at the outset, however. First, the effects of unions upon productivity and other aspects of performance may differ substantially across industries, time, and countries. This is hardly surprising given that both the collective-voice and monopoly activities of unions depend crucially on the labour relations and economic environment in which management and labour operate. Second, union effects are typically measured by differences in performance between union and nonunion firms or sectors. Such differences do not measure the effects of unions on aggregate or economy-wide economic performance as long as resources are free to move across sectors. For example, evidence presented below indicates that union companies in the United States have performed poorly relative to nonunion companies. To the extent that output and resources can shift between sectors, poor union performance has led to a shift of production and employment away from unionized industries, firms, and plants and into the nonunion sector. Overall effects on economy-wide performance have been relatively minor. Most visible, of course, has been the rather precipitous decline in private sector unionism.

What has been true for the United States since the 1980s, however, largely reflects the high degree of competitiveness in the American economy, with the increasing importance of trade, deregulation of important industries, technological change that has reduced the use of production labour, relatively flexible labour market norms, and an economic and legal environment not overly amenable to union organizing and bargaining. The recent experience in the United States was not always the case, nor need it represent the current experience in other countries. The important point here is that the role of unions in society and the effects of unions upon performance are very much driven by the competitiveness of the environment in which firms and unions must operate. An obvious policy implication is that those concerned with economic performance should focus on policies affecting economic competitiveness and resource mobility in general and not only on the structure of labour law in which unions operate.

The measurement of union effects on economic performance is not straightforward. Union effects on economic performance must be estimated using imperfect data and statistical models and techniques that permit alternative interpretations of the evidence. Because of these limitations, one must carefully assess both individual studies and the cumulative evidence before drawing strong inferences regarding unions' causal impact on economic performance.

Most studies utilize cross-sectional data (at single or multiple points in time), measuring differences in outcomes (e.g., productivity) across firms or industries with different levels of union density (i.e., the proportion of unionized workers in the sample being considered). Estimates are based on regression analysis, which controls or accounts for other measurable determinants of performance. The key question is whether, after accounting for other determinants, one can conclude that the estimated difference in performance associated with differences in union density truly represents the causal effect of unions.

There are (at least) three important reasons why one must exhibit caution in drawing inferences from such statistical analysis. First, there are numerous other factors correlated with performance besides unionization. If one fails to control for an important productivity determinant and that factor is correlated with union density, then one obtains a biased estimate of the causal effect of unionism on performance. For example, older plants tend to have lower productivity, and union density is higher in older plants. If a study were to estimate the union impact on productivity among plants, the inability to measure and control for plant age (or its correlates, such as age of capital) would mean that part of the effect of plant age on productivity would be included in the (biased) estimate of the effect of unions upon productivity.

A second reason for caution is that unionization is not distributed randomly across firms or industries or may be determined simultaneously with the performance variable under study; that is, causality may run from performance to unionization as well from unionism to performance. For example, unions may be most likely to organize and survive in firms that are most profitable and, in this case, standard estimates of union effects on profitability (which are almost universally negative) tend to understate the deleterious effects of unions on profits, since unions form where profits (prior to the union tax) tend to be higher.

A third reason for caution in making inferences is that even where one has obtained reliable estimates of union effects for the population being studied (e.g., a particular industry, time period, or country), it is not clear to what extent these results can be generalized outside that population. For example, the most reliable estimates of the effects of unions upon productivity are based on specific industries (e.g., cement, sawmills) where output is homogeneous and can be measured in physical units rather than by value added. Yet, it is not clear to what extent the results in, say, the western sawmill industry can be generalized to the economy as a whole. Indeed, the economic framework outlined previously suggests strongly that union effects should differ across time, establishment, industry, and country.The statistical issues discussed above are more formally known as omitted variable bias, selection and simultaneity bias, and external validity - note

A number of studies combine cross-sectional and longitudinal (i.e., time-series) analysis, typically examining changes in performance over time owing to levels in union density or changes in union status. Recent studies, for example, have examined changes in firm market value (measured by stock price changes), investment, or employment following the announcement of union representation elections. A limited number of studies have examined changes in productivity or other performance measures following unionization of a plant. The advantage of longitudinal analysis is that each individual firm (or plant) forms the basis for comparison-that is, a firm's performance once unionized is compared to that same firm prior to unionization. In this way, unmeasured, firm-specific, attributes that are fixed over time are controlled for in estimating the causal effect of unionization. Despite this considerable advantage, longitudinal analysis can have severe shortcomings since it assumes that changes in union status are not determined by changes in the performance measure under examination, and the period of change under study must correspond closely to the period over which a union impact occurs. For example, "events" studies examining the effect of certification elections on a firm's market value must be careful to compare market value from a period prior to the expectation of a union election with a period in which the full effects of the election on value have been anticipated (i.e., reflected in the stock price).

Evidence on effects of unions on economic performance is analyzed below. Because of inherent evidential and methodological limitations of individual studies, strong conclusions are drawn only where there exists a study of unusually high quality, where there exists a clear correspondence between theory and evidence, or where there are a relatively large number of studies providing similar results.