So what is the solution to this conundrum? Although a more complete treatment will have to wait until Chapter 10, common sense suggests a solution for our present problem. The firm knows that it is going to get ripped off in the second period "come hell or high water". Hence, it expects to be charged the wage rate 14/ = WI' in both periods (t = 1, 2), and bases its investment decision on this knowledge. Indeed, this assumption on the part of the firm is consistent with the actual behaviour of the union.• For that reason, the wage profile (14/, wD is called the time-consistent policy of the union. But, since Ma > W2 (and thus 1,6 > wD, and investment depends negatively on the wage rate in the second period, the firm will also invest less under the consistent wage profile (14/ ., wD than under the inconsistent wage profile vq). Hence, the effect of a union that is unable to stick to its promises is to stifle investment.

8.6 Punchlines