The Keynesian Case Against Labor Unions

The argument is, natch, full of econ lingo, so turn your mind back to ol' "Econ 101″….From Canadian economist Nick Rowe:

When we talk about being paid too much, we should always understand this in real terms. What matters is not how many dollars we get paid; it's how much we can buy with those dollars we get paid. It's the relative price, not the nominal price that matters.

Because each individual faces a downward-sloping demand curve, but all individuals together face a horizontal aggregate demand curve, each individual will choose a price that is too high and a quantity that is too low. Because one individual's selling price is another individual's buying price, all would be better off if all cut prices and increased quantity. Prisoner's dilemma. The attempt by each individual to raise his own real income above the competitive equilibrium results in a lower real income for all.

If all prices are sticky, then an expansionary monetary policy, which increases aggregate demand, increases output and makes everyone better off. That's why booms are good, because it brings the economy closer to the competitive equilibrium. And why recessions are bad, because they take the economy further away from the competitive equilibrium.

And cartels, like labour unions, just make the problem worse. Because by joining together with similar sellers into a group, the demand curve facing the group is  steeper than the demand curve facing the individual, since members of the group no longer compete against each other for buyers. So there is an even bigger difference between the downward-sloping trade-off facing the group of sellers and the horizontal trade-off facing us all.

Unions are bad for the very same reason that recessions are bad.

All New Keynesian macroeconomists have understood the above for the last 20 years. Which is why all New Keynesian macroeconomists are fundamentally opposed to cartels, labour unions, minimum wage laws, etc.. OK. It's why they should be opposed to such things.

[Via Tyler Cowen at Marginal Revolution]