Academic journal article Economic Inquiry

Monitoring of Workers and Product Market Competition: The Role of Works Councils

Academic journal article Economic Inquiry

Monitoring of Workers and Product Market Competition: The Role of Works Councils

Article excerpt


Technological advancement allows firms to closely monitor their workers' actions more than ever before. For instance, firms can acquire worker monitoring software to monitor activities on computers or cell phones. Such software enables firms to assess whether workers play games on their computers or surf the internet, instead of working productively, and even to track workers' exact locations. Similarly, firms scan emails or use video surveillance to monitor their workers' behavior.

Unsurprisingly, the growing use of monitoring technologies has led to a debate on how closely firms should be allowed to monitor their workers' actions and on whether government intervention is needed to protect workers' privacy. At first sight, it appears that this debate centers around two different kinds of arguments: economic arguments (e.g., higher worker productivity) in favor of extensive worker monitoring, against ethical issues according to which workers' privacy must be protected. Schmitz (2005), however, demonstrates that this is not necessarily true. In a contract-theoretical model, he finds that firms employ monitoring technologies not to increase efficiency but rather to reduce rents that must be paid to the workers in the case of imperfect monitoring. He concludes that monitoring technologies may lead to inefficiencies and thus calls for laws protecting workers' privacy.

Whereas worker protection in the United States is rather weak in this respect, it is typically stronger within the European Union. In Germany, for instance, works councils are important institutions that provide workers with power on the firm level, particularly with respect to working conditions. Within the system of "co-determination" works councils have legally guaranteed influence on management decisions concerning working conditions within a firm. For instance, the law prescribes that worker representatives must consent to any introduction of technologies that monitor the workers' effort and output. (1)

Given these rights of works councils, it may be puzzling that firm owners do not (more strongly) oppose this limitation of their control rights. In this paper, we offer an explanation to resolve this puzzle by analyzing the interaction between internal organization and market conduct. We argue that works councils and their right to block monitoring of workers can act as a commitment device of firms to mitigate product market competition. As relaxed competition increases profits, and because workers receive an information rent from their co-determination rights, workers and firms have aligned interests in establishing works councils, at the expense of consumers.

We derive these results in a simple model of two competing firms where each firm faces a moral hazard problem with its workforce that could be solved by installing a monitoring technology. Without monitoring, inducing high effort by workers is more costly. As a result, effort levels will be lower and so will be output. This may serve a similar purpose as quantity reduction in a cartel, and it may thereby increase firm profits. (2) However, similar to quantity reduction in a cartel, also with respect to monitoring there is a danger that a single firm deviates and installs the monitoring technology. Consequently, the deviator can produce higher output more cheaply and free-rides on the lower output of its competitor. Thus, firms would like to ex ante commit not to use a monitoring technology. Usually, no such commitment is possible. However, works councils may serve this (unintended) purpose, because they must give their consent to monitoring technologies. This provides them with a property right on the information rent arising in case of nonmonitoring. To receive their consent, the firm must offer the workers compensation for the foregone rent. This additional cost of monitoring makes deviation from a nonmonitoring situation less attractive, implying that works councils may serve as the desired commitment device. …

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