Can a Marginally Distorted Labor Market Improve Capital Accumulation, Output and Welfare?

This paper sets up an intertemporal two-sector general equilibrium model where capital and labor are complements in production and where the labor market initially functions as a competitive spot market in both sectors of the economy. The purpose is to analyze how the introduction of a marginal distortion on the labor market in one sector of the economy (here represented by the formation of a trade with a bargaining power marginally above zero) affects factor prices, the allocation of per-worker capital between the unionized and non-unionized sectors of the economy, aggregate saving, capital accumulation, output and welfare. It is shown that if the output elasticity w.r.t. capital is larger (smaller) in the unionized sector than in the non-unionized sector of the economy, then the formation of a weak trade union leads to a reallocation of capital and labor in such proportions that the per-worker capital stock increases (decreases) in the non-unionized part of the economy. This leads to a higher (lower) non-union wage, a reduced (increased) interest rate and an increase (decrease) in aggregate saving. The savings effect implies that the steady-state capital stock and the steady-state aggregate output both increase (decrease). It is also shown that if the output elasticity w.r.t. capital is larger (smaller) in the unionized sector than in the non-unionized sector of the economy, and if the steady-state capital stock initially exceeds the Golden Rule capital stock, then the formation of a weak trade union has a negative (positive) effect on the steady-state welfare.