David R. Henderson  

The Minimum Wage and Monopsony

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I promised a few weeks ago to "write a further note explaining a more-sophisticated way of understanding the harmful effects of the minimum wage." This isn't it.

The reason is that three issues came up in the comments and e-mails and I want to handle them first. The promised follow-on post will come in another few days.

The three issues were:
1. Arguments for the minimum wage as a way of helping some low-wage workers even if the employment effects are negative.
2. Questions about why imposing a minimum wage in a monopsony situation could increase employment and efficiency.
3. A question about why unskilled workers are actually the least likely to face monopsony.

Here are my responses in order.

1. I should have specified in my original post, but didn't, that I was giving the student who asked the original question the best (and really only) argument one could give for a minimum wage increasing efficiency. It's easy to come up with arguments for a minimum wage when you equally weight the dollar losses to those who lose their jobs and the dollar gains to those who get higher wages. But then you're leaving out the main losers: employers and, ultimately, consumers who pay somewhat higher prices for the goods and services produced by the minimum-wage workers. I was excluding these kinds of arguments because, to repeat, I was looking for only pro-efficiency (in the economist's sense of efficiency--gains from the change in $ terms exceed losses in $ terms) arguments.

2. The student at Susquehanna University told me by e-mail that he didn't understand the monopsony argument. I still have not got around to learning how to put a supply demand graph on Econlog. I will learn, but not today. Fortunately, I don't have to reinvent the on-line monopsony graph. Here's the best one I have found.
In the figure, Figure 14.9, if the employer is a monopsonist unconstrained by a minimum wage, he will hire Lm of labor because at that point, his marginal revenue product (MRP) equals marginal factor cost (MFC). Reading down from the intersection of the two lines to the supply curve (S), we get that the wage is $4 an hour.
But the efficient amount of labor is the amount where the supply curve intersects MRP. That point, unfortunately, is not labeled in the graph. You can tell, though, just by eye-balling, that that point is at a wage of approximately $4.70 an hour. So if the government imposes a minimum wage of $5.00 an hour, it will cause the MFC curve to be at $5 up to the point where $5 and the supply curve intersect, and then will jump to the old MFC. With this new MFC curve, they will employ L2. Notice that is more than the number of people employed when there was no minimum. QED.
The government could make the situation even more efficient by setting the minimum wage at $4.70 an hour rather than $5.00 an hour. I leave that as an exercise for the reader.

3. In my previous post, I wrote:

I don't find the monopsony claim persuasive. Monopsony requires that the employer have no or few competitors trying to hire the same kind of labor. It is precisely the fact that the workers are unskilled that gives them many potential employers.

In response to this, Sam Raptis wrote:
Could anyone explain the reasoning behind Henderson's claim toward the end of the article that "It is precisely the fact that the workers are unskilled that gives them many potential employers." is true? I'm not doubting it, but I found it confusing since I would tend to think the opposite.
Yes. Many, many potential employers want relatively unskilled labor for unskilled tasks. So there are many potential employers for the unskilled. Go to Home Depot sometime and watch how many people drive up with cars and pickup trucks and hire (in my area, anyway) Hispanic workers for a day. Now imagine that the worker is an astronaut. This is highly skilled. How many potential employers are there? Or, imagine that the worker is a professional basketball player and is highly skilled. How many potential employers are there?


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COMMENTS (29 to date)
Nick writes:

For (3), do minimum wage workers perceive it to be the case that their employers have little market power?

It's not necessarily true that monopsony only results when there are no alternative employers in the market. It results when switching / quitting is expensive for workers.

For low wage workers, it may be tempting to say "This is a lousy job, I quit," but if you have no savings or money to live on, looking for another job is expensive and risky. That's the source of the monopsonistic market power that low-wage employers have.

Or so the argument goes. I'm not saying I agree that the minimum wage is a good policy, but, I don't think reducing the monopsony argument down to asking how many employers there are in the market provides a good summary of the argument.

David R. Henderson writes:

@Nick,
I think the number of employers in the market is a good summary statistic, just not a perfect one, for the reason you mention. If there are a lot of potential employers nearby, the switching cost should be low.

Nick writes:

Maybe... whether that's true or not seems to me to be an empirical question, which brings us back to square one. And while I can imagine labor markets in which low wage workers can easily switch, I can also imagine lots of labor markets where that isn't true. For example, Walmart is such a massive employer, they must have some market power.

If the empirical literature in sum broadly fails to find a significant effect of the minimum wage on employment, that is empirical evidence in favor of the theory that low wage employers do in fact have market power. It may be weak evidence, but it seems stronger to me than your intuitive feeling that low wage employers should have less market power.

Especially considering that if you tend to support minimum wages, you also probably tend to subscribe to the Walmart view of the labor market, so it's not surprising to me that some people feel that the opposite of your claim in (3) is true.

David R. Henderson writes:

@Nick,
For example, Walmart is such a massive employer, they must have some market power.
That doesn’t follow. Walmart is a massive employer. But the issue in a particular labor market is whether it hires a large percent of that type of labor.

Nick writes:

You're making a lot of empirical statements (low wage workers have outside options at other companies, number of nearby employers is a good summary statistic of market power, workers in the Home Depot parking lot have more employment options than professional basketball players) and not providing much in the way of supporting evidence beyond, as far as I can tell, your gut feelings about the state of the labor market.

Say we were to survey professional basketball players / lawyers / fast food workers and ask them how much power they felt they had to threaten to quit their current team / firm / restaurant. It seems entirely plausible to me that fast food workers would report that they felt they had the least bargaining power.

So yes, it doesn't follow that Walmart has market power just because they employ over 1% of the workforce -- but it's at least plausible, and I think you should address it if you want to argue that the monopsony story doesn't hold water. I'm not trying to convince you that the monopsony story is true. I'm not sure if it is. I'm questioning your certainty.

David R. Henderson writes:

@Nick,
So yes, it doesn't follow that Walmart has market power just because they employ over 1% of the workforce -- but it's at least plausible, and I think you should address it if you want to argue that the monopsony story doesn't hold water.
I did address it in the comment directly above your latest.

john hare writes:

The perceived monopsony has at least as much to do with the low skilled workers perceptions of their own value as the actual power of a Walmart employer. When they perceive their own value as being low, they are far more likely to put up with a poor job rather than stick their necks out. A self-fulfilling prophecy develops in that they see no way out because they are afraid to look. They also become less capable as they turtle up. The ones that are capable or have the courage to move on normally do better later on.

David Cushman writes:

The online graph focuses on one firm and implicitly assumes other things stay the same. That might be fine if the firm were a monopoly in its output market. But suppose it is in a competitive output market where all the firms are monopsonists in their labor markets (one company towns in a world market). Then, before the wage is raised, all the firms are earning zero economic profits. When the wage is raised, all firms’ costs rise and, in due course, some go out of business. So, each remaining firm is hiring more labor, but there are fewer firms, and they have higher costs. Thus, price must rise and quantity demanded in this market must fall. It seems then, that the employment effect is ambiguous, not a definite expansion as in the online graph.

R Richard Schweitzer writes:

Are "wages" a form of "prices?"

If so, are they not then part of the "signaling" or information system of a market economy?

Have price controls been found to disrupt that information system?

Do legislatively mandated wages qua "prices" disrupt that system?

What are the distinctions?

tom writes:

@Nick,

My experiences in and around low paying jobs indicate that there is relatively little concern about finding a new job when you already have one. The best rule of thumb for hiring is to ask "when can you start" and hire the person that says "two weeks from now", that indicates that they have a job, and are treating their current employer well by giving notice. Quitting and then looking for a new job is extremely stressful as you said, and a big no no. However it is rare that you need to quit to look for a new job, and you can get a good feel for the market just by picking up the want ads and talking to other low wage workers.

Anecdotally it isn't even necessary to look. I once got a buck an hour pay bump just by mentioning to a manager that I was looking for a 2nd job for some extra income. Rather than risking that I found a better paying job and totally switched or that the 2nd job cut into my hours they were flexible.

David R. Henderson writes:

@R Richard Schweitzer,
Are "wages" a form of "prices?"
Yes.
If so, are they not then part of the "signaling" or information system of a market economy?
They are.
Have price controls been found to disrupt that information system?
Yes.
Do legislatively mandated wages qua "prices" disrupt that system?
Yes.
What are the distinctions?
There is no important distinction between wages and other prices. And so, just as one can show that a skillfully set minimum wage on a monopsony can increase employment, so one can show that a skillfully set maximum price can increase output in a monopoly.

Nick writes:

@David R Henderson
I did address it in the comment directly above your latest.

Yes, I agree that just because Walmart is a large employer does not necessarily imply they have market power. But that doesn't mean they do not have it, and it is strongly suggestive that they do. Since you're claiming they do not, I feel the burden of proof is on you to provide some evidence.

You keep stating that they do not, as if it should be obvious to anyone who bothers to look.

But the fact is that a substantial fraction of people disagree with you and do not perceive the world to be one where low wage workers have many outside options.

Actually, since this is the question that much of the empirical debate hinges on, if you don't address it how can you claim to be engaging the other side? They can marshal empirical evidence in their favor. At best, you've presented a few anecdotes.

Normally, I find your writing persuasive, and I happen to agree with you on the topic of the minimum wage -- but why you think anyone who disagrees will be convinced by point (3) is completely beyond me.

ted writes:

I was lucky to get my first job, in a certain West-European country, as an immigrant, a couple of years before the minimum wage law was introduced.

I got paid about half of what the minimum wage was going to be.

Still, this was a good deal for me. I was very young and had no dependants/loans/etc, I could live in very cheap, unpretentious student-type accommodation (and I did), so I could just about get by.

However, in that first job I made friends and contacts that directly got me the 2nd, 3nd and 4th jobs - and the last one was very well paid.

As it happened, because I had to fly to get this first job (and I had no money), I had to be creative and find a temporary contract to make enough money for the plane fare. This in turn got me another friend, who's now my wife.

To recap: my crappy, half of the future minimum wage job got me (1) my career, (2) lots of good friends, and (3) my wife.

Would they had hired me at the future minimum wage to begin with? I am absolutely convinced that they wouldn't had. My work was simply not that valuable to them. My life would had been totally different, and I'm pretty happy with the way it went.

Thinking that a "progressive" would congratulate himself for "saving" me is frankly nauseating.

Is it worth destroying the life prospects of some people, to force employers to pay others slightly above their productivity? It doesn't strike me as being humane or just.

Hasdrubal writes:

A timely bit on Wal Mart and wages:

"It's raising wages for workers not because it wants to be nice, but because the market for people who can do Wal-Mart jobs has tightened in recent years as modest job growth has been restored to the economy.

The reason for this? In a word, competition."

Two things I get from this:

1.) Even a corporation that employs a full 1% of the population doesn't have the market power to drive down wages the way an evil robber baron caricature would like.

2.) This looks like a shift in the demand curve for labor. What would a monopsony look like?

2.a.) If it were a monopsony, is Wal Mart's employment + wage level guaranteed to be inefficient? Are they certain to be hiring such that Marginal Factor Cost = Marginal Revenue Product, or could they be hiring at Supply = MRP or somewhere in the middle for "other reasons"?

2.b.) Even if it faces a sloped supply curve, is there evidence that regulation is better at maximizing total welfare than competition in this type of situation? Not just wages, but the ACA, OSHAA, etc?

David R. Henderson writes:

@Nick,
Yes, I agree that just because Walmart is a large employer does not necessarily imply they have market power. But that doesn't mean they do not have it, and it is strongly suggestive that they do. Since you're claiming they do not, I feel the burden of proof is on you to provide some evidence.
How does the fact that Walmart is a large employer “strongly” suggest that it has market power? I’m not asking even for proof, as much as I’m asking for a reasoned argument.

R Richard Schweitzer writes:

@David Henderson;

Thank you for the confirmation. You say:

" . . . just as one can show that a **skillfully** set minimum wage on a monopsony can increase employment, so one can show that a **skillfully** set maximum price can increase output in a monopoly."

Whence cometh such "skill?" From the fab 545?
From the San Francisco City Council; State Legislatures?

How would that "skill" be informed to make the "set?"

David R. Henderson writes:

@R Richard Schweitzer,
You’re welcome.
Whence cometh such "skill?" From the fab 545?
From the San Francisco City Council; State Legislatures?

No. That’s unlikely.
How would that "skill" be informed to make the "set?"
Very badly.

Nick writes:

@David R. Henderson
How does the fact that Walmart is a large employer “strongly” suggest that it has market power?

One way that market power is obtained is by forming a large share of the market. For example, if half of all the possible jobs you might take are with Walmart, you're half as likely to find work if you don't work there as if instead there were many different employers.

That's one possible way. It may also be that there are switching costs or that low wage workers find unemployment particularly costly, having no savings. It may be that low wage workers learn a very particular set of skills for each position they take, and moving jobs destroys those accumulated skills. (For example, if you work in the kitchen in Taco Bell versus McDonalds you have to learn a different set of actions and rules.)

You argue that, intuitively, you don't feel that these are especially important factors for low wage workers. But others disagree. Here's a recent paper (bold added by me) discussing some of these channels:

"It has long been recognized that for the imposition of minimum wages to have beneficial effects... ...firms must have some degree of monopsony power... Search frictions and the existence of match-specific capital are capable of providing this. The existence of both seems in accord with common sense and empirical findings (on the existence of match-specific capital see Miller (1984) and Flinn (1986), for example)"

http://www.nyu.edu/econ/user/flinnc/papers/mw-flinn.pdf

Whether firms have market power is an empirical question, not one that will be settled by reasoning about our own personal experiences.

R Richard Schweitzer writes:

@David Henderson,

Such candor is absolutely disarming.

David R. Henderson writes:

@R Richard Schweitzer,
Such candor is absolutely disarming.
:-)
Just to remind you of the context, if you’re arguing that government officials don’t have, can’t have, and can never have enough information to “skillfully set” a minimum wage, I’m in 100% agreement.
The context, though, was a student’s question about what would be the best argument the pro-MW side could make. The argument I gave is it.

David R. Henderson writes:

@Nick,
One way that market power is obtained is by forming a large share of the market. For example, if half of all the possible jobs you might take are with Walmart, you're half as likely to find work if you don't work there as if instead there were many different employers.
Exactly. And what’s missing from your account is any data on what % of possible jobs are with Walmart. You argued that the “Walmart as monopsonist” argument is plausible based on Walmart’s over 1% of the work force. What you have steadfastly refused to do is say what % of unskilled jobs in a given area are filled by Walmart employees. My guess is that it’s over 1% but well below 50%.
Whether firms have market power is an empirical question, not one that will be settled by reasoning about our own personal experiences.
We agree. At no point did I say that my reasoning “settled” the argument. I was giving my thoughts. My thoughts could be wrong.

Nick writes:

@David R. Henderson
My guess is that it’s over 1% but well below 50%.

I don't doubt it. But you are the one claiming that low wage employers do not have market power; you should be the one to provide evidence to support that claim. Initially you seemed incredulous that any evidence was required, so I listed several possible ways low wage employers may have market power beyond the ones you mentioned. I linked to published research arguing that the empirical evidence supports the thesis that they do.

(By the way, you're focusing exclusively on my example of Walmart and ignoring the other possible channels I listed.)

I was giving my thoughts. My thoughts could be wrong.

Of course if you were simply sharing your personal thoughts about how you see the labor market, then I withdraw my criticisms -- but if you intended this to be an 'argument against the devil', I don't think it holds much water.

ThomasH writes:

About 1)
I may be one of those who found it odd to interpret a question about the "best" argument for a minimum wage to mean an efficiency increasing argument. "Best" should probably be interpreted as "best among those actually made." I do not think there are very many minimum wage proponents that favor it on grounds that it is a movement towards a Pareto optimum.

Rather, proponents think of the minimum wage as a way to transfer income from higher income people to low income workers. The "best" argument in this context would that a minimum wage is the lowest cost way to achieve this goal and would involve arguments about elasticity of demand for low income workers and the incidence of the implicit tax on consumers, owners of other factors of production and low income workers themselves along with arguments about why alternative ways of transferring income are either politically infeasible or have even higher costs.

In other words, I'd interpret the student's wish for the "best" argument as the one which, if successfully refuted, would lead the minimum wage proponent to change their mind. I doubt that successfully showing that a minimum wage is not Pareto optimal would do that.

David R. Henderson writes:

@ThomasH,
Your point is well taken and well stated. You could be right. The reason I went with monopsony, though, is that so much of the debate has been about whether an increase in the minimum wage reduces or increases the employment of low-skilled workers. Granted, that that’s relevant to the issues you raise (viz, your point about elasticity) but it’s also relevant to the monopsony issue.
I’ll wait until I hear back from the student before taking up the other ones.

ThomasH writes:

About the minimum wage issue on this site)

The corporate tax code is filled with provisions that make the marginal revenue of capital employed in one or another line of activity higher or lower than it's pre-tax marginal product. It is hard to believe that the efficiency losses of a minimum wage are greater than these distortions in the corporate income tax. Yet the relative salience of the two issues on this site is enormous. (I don't recall a single thread on the corporate tax distortions.)

Since the apparent first order effects of a minimum wage are to shift income to low paid workers and the first order effects of corporate tax "loopholes" are to shift income to shareholders and I've never seen it argued that the dead-weight losses of the former are greater than the latter, the impression that anyone who is not already pretty favorably inclined toward Libertarianism would be that Libertarians think wealth-destroying distortions are not so bad unless their income distribution effects is "progressive."

There are probably some sociological reasons for this apparent disparity, but are there any economic reasons?

David R. Henderson writes:

@ThomasH,
There are probably some sociological reasons for this apparent disparity, but are there any economic reasons?
Yes. And you know the reason because I already gave it the last time you asked.

Floccina writes:

Speaking of basketball players the NCAA has close to Monopsony power and the wages are quite low indeed.

ThomasH writes:

Thanks for the reply, which I do not remember having seen. Mea culpa.

Not to make this about your personal interest in minimum wages, (my peeve with opponents of the XL Pipeline cannot be explained by the contribution of this project to GDP) but if this was the reason most opponent had for opposing minimum wages, would they not support things like an increase in the Earned Income Tax Credit or exempting the first $X of wages from payroll taxes which would not have the effect of pricing the lowest productivity workers out of the market as an alternative?

Roger McKinney writes:

There was a popular outcry for a minimum wage in Europe during the 16th century so the scholars at Europe's top university at Salamanca, Spain looked into it. They all decided against it because they understood it would hurt the poor.

Keep in mind those the scholars at Salamanca were also theologians for whom concern for the poor was the highest.

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