From first- to second-generation social pacts

In this chapter we analyze macroeconomic interactions among trade unions, the central bank and the fiscal policymaker. We explicitly model trade unions’ concern for public expenditure, paving the way for an analysis of the potential gains from cooperation between the fiscal policymaker and the trade unions, i.e. the socalled corporatist or social pacts that have characterized economic policies in a number of European countries in the last few decades. Theoretical analyses of macroeconomic outcomes in corporatist economies are relatively scarce. In the 1980s, Cameron (1984) and Tarantelli (1986, 1987), among others, argued that cooperatively determined wages can ensure the same disposable income for wage earners while resulting in a higher level of employment and a lower inflation rate. Summers et al. (1993) pointed out that in corporatist economies interdependence between monopolistic unions and fiscal policymakers limits the distortionary effects of taxes, inducing an exchange between public expenditure increases and wage restraint. More recent contributions suggest that cooperation may improve macroeconomic performance. However the analysis is restricted to the interaction between trade union behaviour and monetary policy. 1 In this chapter we revisit the case for corporatist agreements in a model where labour markets are unionized, the government controls the fiscal stance, and an independent central bank sets monetary policy. We can then analyze the scope for a political exchange between public expenditure and wage setting choices, showing that corporatism may generate quite different macroeconomic outcomes from the traditional exchange between wage moderation and high public expendi- ture. In fact our model can give account also of pacts where unions accept a lower level of public expenditure. Our approach stands in sharp contrast with those in the literature on macroeconomic policy games, where the importance of institutional arrangements in shaping macroeconomic outcomes is a key ingredient, but the focus is restricted to institutional constraints on policymakers. Typically, central bank conservatism and institutional constraints on fiscal discretion are deemed to enhance macroeconomic efficiency, i.e. to produce lower output distortions and inflation. For instance, Beetsma and Bovenberg (1998) obtain these results by implicitly or explicitly assuming a given labour market performance and neglecting interactions between this market and fiscal and monetary policies. Some analyses do in fact endogenize trade union behaviour but focus on monetary policy as the sole tool available for stabilization purposes. Contributions in this vein emphasize that the central banker’s idiosyncratic preferences, either conservative or populist, can have a whipping effect on union behaviour, thus inducing a reduction in output distortions.2 We show that in unionized economies attempts to reduce fiscal distortions either through central bank conservatism or by imposing institutional constraints directly on the fiscal policymaker may be ineffective, as the potential output benefits from fiscal discipline are offset by higher real wages.