Firm formation and economic growth: the effects of labour union bargaining power and of worker mobility

A model is presented where economic growth is co-determined with the number of entrepreneurial firms as functions of union wage bargaining power and of inter-firm labour mobility. There is an inverse-U relationship between economic growth and the number of firms, if they are both heterogeneous and operate under decreasing returns to scale. If labour is immobile, economic growth is greatest where unions have a moderate degree of wage bargaining power, because this deters less able entrepreneurs from setting-up firms without discouraging too many of the more able ones. However, if labour is highly mobile, economic growth is greatest where union wage bargaining power is very weak - although not necessarily greater than in the immobility case - because the anticipation that workers can switch from lower to higher ability/wage firms acts as a very powerful entry deterrent for all but the highest ability entrepreneurs. Between these extremes, the model points to two empirical findings, a the positive correlation between the wage and firm-size, and, for some parameter values, a negative cross-country relationship between economic growth and income inequality, because countries with more labour mobility should have less wage inequality as well as greater allocative efficiency.