Employment Policies, Wage Formation and Trade Union Behavior in a Small Open Economy

A model of trade-union determined wages is developed which provides an explanation of underemployment based on optimizing behavior. It is shown that fiscal policy will in general affect employment under perfect foresight and immediate wage flexibility. Future consequences of short-run stabilization policies are discussed. Ratchet effects with respect to government expenditure and game-theoretic interdependence between government and trade union behavior are emphasized. If the trade union takes short-run policy measures in order to increase employment as an indication of an employment stabilization rule, the future behavior of the trade union changes and the result may be a decrease in long-run employment.