Externalities in Wage Formation and Equilibrium Unemployment

We provide a multi-sector general equilibrium model in which externalities among sectors arise trough decentralized wage bargaining. Without externalities, equilibrium unemployment is only a function of firms’ market power and of demand uncertainty. With externalities, unemployment is higher. It is increasing with union power even thought bargaining is efficient. Demand does not modify the magnitude of the loss of efficiency. However, when externalities are present, sectorial demand shocks modify the allocation of output across sectors ; this reallocation may increase or decrease unemployment depending on the initial situation of the economy.