PROFIT‐SHARES, BARGAINING, AND UNEMPLOYMENT

I. INTRODUCTION Weitzman [1987] has argued that in an economy with long term unemployment due to extra-competitive wages, profit sharing can eliminate this unemployment by lowering the marginal cost of labor. Jackman [1988] provides additional microfoundations for this claim by modeling long term unemployment as arising from an externality in decentralized wage setting. In that model, a mandated profit share lowers wages and raises net profits, thereby inducing the entry of firms into the market, unambiguously lowering unemployment and leaving the real wage unchanged in general equilibrium. The generality of this result is put into question by Holmlund [1990] who considers a similar case, but with the capital stock fixed economy wide, and shows that profit sharing may raise or lower unemployment depending on standard properties of the production function. In that short run model, firms implicitly operate on downward sloping labor demand curves, so profit sharing expands employment only to the degree that it reduces wages in general equilibrium. If the labor demand elasticity is great enough, the general equilibrium effect of profit sharing is to raise wages and lower employment. Holmlund also shows that his result is independent of whether the profit share is bargained over or mandated. In models with variable capital, the question of the effect of profit sharing on employment does not reduce to the question of its effect on wages. The introduction of profit sharing also affects net profitability and so may lead to an inflow or withdrawal of capital in the market in the long run, further influencing employment. In Jackman's model, employment unambiguously increases. However, Jackman only considers a mandated profit share under "monopoly union" wage setting, leaving the impact of bargaining over profit shares and wages unresolved. Further, substantial structural differences in the models of Jackman and Holmlund make direct comparisons of these models difficult. In the present paper, I present a model in the spirit of Holmlund's, but with free entry of firms subject to overhead costs, and show that under Nash wage bargains the effect of profit sharing on both employment and compensation depends on whether the profit share is bargained over or mandated as well as on the profit accounting used to determine share payments. Of particular interest is the possibility that profit sharing may reduce both aggregate employment and total compensation per worker due to general equilibrium effects. No such possibility exists in the models of Jackman and Holmlund. Profit Sharing, Employment, and Bargaining As is well known, if Nash bargaining is over both wages and employment, then profit sharing leaves microeconomic employment and incomes unchanged. Further, under unilateral employment setting by firms, Nash union wage and profit share bargains emulate Nash bargains over wages and employment (Pohjola [1987], Anderson and Devereux [1989], Johnson [1990]). In partial equilibrium, the ability to bargain over either profit shares or employment in addition to wages raises employment and is Pareto improving. In general equilibrium, however, reservation utilities may rise enough to cause wages to rise and employment to fall. This is shown by Layard and Nickell [1990] for bargaining over employment and by Holmlund [1990] for bargaining over profit shares. Both models are short run models in which the capital stocks are fixed economy wide. Holmlund goes further to show that the same mechanism also operates for mandated profit shares. In the long run model presented here, Holmlund's result for bargained profit shares continue to hold (as does Layard and Nickell's for bargained employment), though for different reasons. The introduction of profit sharing does not produce upward wage pressure, since free entry eliminates profits and thus any direct effect of profit sharing on reservation utilities. Rather, employment is reduced if it reduces profitability and so yields exit of capital sufficient to offset the positive effect of reduced wages on employment. …