Efficient Wage Bargains Under Uncertain Supply and Demand

Much recent thought has been devoted to the macroeconomic importance of the existence of wage contracts. Still, some puzzling features of the most conspicuous form of wage bargaining, that done formally by employers and labor unions, deserve further theoretical attention. Among these important features are: 1. Collective bargaining agreements are rarely contingent on outside events even though the parties have very imperfect knowledge of prospective economic conditions during the period of the contract. The only important exception is the indexing of wages to the cost of living. 2. Employers are permitted wide discretion in determining the level of employment when demand shifts unexpectedly. As employment varies, total compensation varies according to a formula established in the agreement. 3. Agreements are not permanent but are renegotiated on a regular cycle. 4. In the process of renegotiation, the current state of demand has little impact on the new wage schedule. On the other hand, current wages in other industries have an important influence. This feature especially has been denied or ignored by economic theorists even though it is a prominent part of the thinking of labor economists on wage determination.