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Why Labor Unions Are Inefficient Monopolists

This article is more than 10 years old.

Let us begin with a parable: assume that a group of workers wish to come together to form a new business. They are all identical in their skills and aspirations. They wish to avoid the nasty capitalist tradition associated with such unwholesome institutions like corporate shares and--shudder--employers. So all of them agree to form a business to which they contribute identical sums of money and work for identical wages. Lo and behold, the scheme seems to work for a while and the workers dutifully enjoy the increased value of their original stakes.

Now the most prosaic of events comes to pass. Some of the workers wish to retire and so others have to replace them. So just let the new workers step into the shoes of the old ones, and the transition is done in an orderly fashion. But one nagging question remains: What about the appreciation in the value of the interests to which the retiring workers have contributed much and the new workers nothing?

Making a simple substitution is an implicit transfer of wealth from the worker who created it to the one who did not. So what is the best way for an old worker to retire and a new one to come into the business? It's simple; create shares in the business, which are then given to all the old workers. These shares command both rights to dividends and capital appreciation, past and future. The new worker gets paid a competitive wage and all is well--except the naïve view that even in ideal circumstances economic business can happily dispense with shares and employers.

What happens if we introduce monopoly power of the firm into the equation? In an ordinary business with shares, the sensible approach is to pay competitive wages to workers and distribute the monopoly profits pro rata to the shareholders. Since all of these hold fungible shares in (typically) a single class of stock, any firm decision that benefits one shareholder benefits all. The monopolist therefore will be efficient in extracting its profit. The only social losses that it will create stem from the usual monopolistic tendency to raise prices above competitive levels while cutting production.

Labor unions are also monopolists. But, like our worker cooperative, they cannot issue shares that allow members to divide the profits by some pre-arranged formula. So they have to find some other way to deal with the distributional problem of how to divide the economic rents--the increment of wages above the competitive level--among all its members. Unfortunately, all the ways that allow this to be done are inefficient.

A primary example of this is the work rules that divide up tasks inefficiently in ways to insure that some work is available for each worker. To do the same task with fewer workers means some union members have to be cut out of their share of the union's monopoly rents. That in turn creates instability in its political organization.

But when a downturn hits, the situation can become grotesque. Think of the featherbedding under the Railway Labor Acts when the fireman who shoveled coal could not be laid off when the railroads converted to Diesel engines. Or think of the job bank programs at the Big Three auto companies that pushed them closer to the precipice of failure. There is no efficiency gain in such perverse procedures that are needed to divvy up the wealth. A more sensible response would have been simply to provide those workers with shares in the company, but that would be an open admission of the coercive power that unions receive even under the current labor statute.

Nothing under the Employee Free Choice Act can change these regrettable dynamics. The combination of its card check provisions and its mandatory interest arbitration provision will surely change the balance of advantage in labor organization. The card check will make organizing easier; the mandatory arbitration will increase the gains to labor from organizing.

The only real dispute is how profound the changes will be. But one point will remain constant. The distributional issues that face all unions mean that they will continue to push for inefficient labor structures that share the wealth among union members--and pave the seeds for long-term industry decline.

No legislative reform can make unions into efficient monopolies. The best we can hope for is that strong competition from the outside will erode their monopolistic profits.

Richard A. Epstein is the James Parker Hall Distinguished Service Professor of Law, the University of Chicago; the Peter and Kirsten Bedford Senior Fellow, the Hoover Institution; and a visiting professor at New York University Law School. His most recent book, The Case Against the Employee Free Choice Act, will be out shortly from the Hoover Press.