The Macroeconomic Effects of the New Fiat Labor Contract

Today, workers at the Mirafiori plant in Turin will be asked to approve or reject a referendum for a new labor contract, signed by Fiat and various trade unions, but rejected by the FIOM, the leftist and powerful union of metal workers. The new contract derogates from the current system of  industrial relations which is based on a “national contract”, and is part of an exchange between more flexibility, tougher controls  against absenteeism, stricter rules for illness-leave and reduction of work pauses,  against Mr. Marchionne’s (Fiat’s CEO),  rather vague promises of new investments and higher wages.

The debate in Italy has been divisive and heated, with those in favor, welcoming an epochal change in industrial relations and the end of the class struggle legacy of the 70s, and those against, denouncing a frontal attack on workers rights, and blackmail made under the threat of outsourcing production elsewhere (Serbia, Poland, Brazil or the US).  The debate has mostly focused on issues of workers’ representation. In a functioning system of industrial relations, workers should delegate to their elected representatives to negotiate with the firm. In the present case, paradoxically, the new contract established that only those trade-unions that have signed the contract (and whose representativeness at the plant has not been tested) will be entitled in the future to represent the workers to whom the contract applies.

In short, the concerns of Fiat can be understood by what economists call the hold-up problem in negotiations. Before making the investments, the bargaining power of Fiat is very high, because it can credibly threaten to move production abroad if its demands are not met; but after making the investment, that threat is not credible, since leaving behind the investment would be too expensive. Thus the bargaining power of Fiat becomes very weak. From here comes the firm’s desire to predetermine who will be its counterparts in future negotiations.

The debate has largely ignored the macro-economic consequences of the Fiat plan. What would happen to employment and real wages if the Fiat plan were to be extended to the whole system of Italian industrial relations? The answer is that, in the short term (before the new investments) the real wage is likely to fall and employment to increase. In the medium term (after the investment), the real wage should increase along with employment. Here’s why.  

First, we must define what is meant by the new “Fiat contract” (and what theoretical framework we want to adopt, in this case the efficiency-wage model of Shapiro and Stiglitz (1), see in Appendix). For the “Fiat contract” I mean this: initially, the company introduces a more effective discipline device that reduces work-breaks and provides tighter controls for leave, sickness and absences. In a second step, the company carries out productive investments that increase the productivity of labor. The first effect of the new contract is to make it easier to discover “shirking” workers, for whom the risk of being laid off increases. As a result, in the logic of the model, a lower wage is required to elicit the workers’ effort. As the bargaining power of workers falls, so does the real wage. In turns this makes it more convenient for the firm to recruit new workers. Thus in the short term, employment grows and real wages fall. In the second step, Fiat invests in the plant and this raises the productivity of labor. The demand for labor by the company increases and these result in higher employment and wages.  

Conclusion: It is reasonable to think that the new Fiat contract will lead to a rise in employment in both the short and medium term, while the initial reduction in real wages, due to the deterioration in the bargaining position of workers, will tend to be transient and will be absorbed by new investments.

References

(1)  C.Shapiro, J. Stiglitz, Equilibrium Unemployment as a Worker Discipline Device, American Economic Review, 1984

Appendix The model of Shapiro and Stiglitz is well suited to answer our question. The model, shown in the Figure below, consists of two curves.

manasse_11411.jpg  

The downward sloping curve (Ld) is the labor demand by firms, and relates the number of workers hired (NL, on the x axis) and the real wage (w, on the y axis): the higher the wage, the lower the firm’s demand for labor. The second curve (NSC, No shirking condition) is positively sloped, and describes the real wage which makes the worker indifferent between shirking (and risking to be fired) and eliciting effort on the job. If employment is low (and unemployment high) it will be difficult to find a new job if one is fired, and therefore a relatively low salary will be enough to convince the worker to be exert effort. Conversely, if employment is high, being laid-off is not too costly, since it will be easy to find a new job. Hence a higher salary will be required to convince the worker not to shirk.  For these reasons, the NSC curve is positively sloped. In the model, wages and employment are jointly determined when both relations are satisfied, at the intersection of the two curves, point Q. The first effect of the new contract is to make it easier to detect shirkers, for whom the risk of redundancy rises. Thus a lower wage is sufficient to convince workers to be productive and NSC curve shifts down. As the bargaining position of workers falls, the real wage declines and employment rises (point Q shifts down to the right). When the Fiat’s investments occur (they should be unexpected for their effects to materialize only at the time they are made), the productivity of workers rises and the demand for labor increases: the LD curve shifts upward. This effect produces an increase in employment as well as in the real wage.