Unions and Workforce Adjustment Costs

We present an economy composed of many sectors. In each sector, a simple dynamic stochastic game is played between a wage-setting union and many competitive firms that choose employment. Firms are subject to linear workforce adjustment costs whilst the union, along with employment and wages, is also concerned with limiting the number of insiders fired during business downturns. We show that the interaction between mandated firing costs and the protection of insiders operated by the union through the wage policy reduces the effect of the former on the job turnover rate. In particular, the negative relationship between turnover and firing costs may be so weak that it could easily escape empirical detection. Thus, the paper offers a potential explanation for the surprisingly similar patterns of aggregate job turnover exhibited by OECD countries despite large differences in the stringency of legislated employment protection.