Unions, Firing Costs and Unemployment

Abstract

In this paper we conduct an analysis of the effects of firing costs in models that considersimultaneously worker heterogeneity, imperfect information on their productivity and unionpower. We consider an OLG model where heterogeneous workers participate in the labourmarket both when young and old. Each generation of workers is represented by its ownunion. Unions set wages unilaterally taking into account firm behavior. Firms are atomisticand choose employment treating wages parametrically. There is imperfect information aboutworker productivity.We find that at given wages firing costs increase youth unemployment and decrease old ageunemployment. However, once we take the wage response into account, we find that firingcosts increase both youth and old age unemployment. This happens because unions reactstrategically, and respond to higher firing costs. Indeed, when firing costs increase, firmsrefrain from hiring youths since, if a young worker turns out to be inadequate, it will be morecostly to fire him. The union, knowing this, reduces the wage of young workers in order toattempt to increase their employment prospects. However, despite this cut youthunemployment still increases with firing costs. In the second period, on the contrary, higherfiring costs give the union more power. In fact, knowing that firms will be less likely to cut theirlabour force when firing costs are high, the union increases the wage of old workers, and,therefore, old age unemployment increases.

Keywords: unions, unemployment, firing costs, worker heterogeneity

JEL Classification: D83, E24, J65