David R. Henderson  

The CEA's Mixed Thinking on Labor Market Monopsony, Part III

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On Thursday I posted on the CEA's report on labor market monopsony. On Friday I posted Part II. Here is Part III. I analyze the report seriatim.

The Minimum Wage

The CEA writes:

Economic theory suggests that in competitive markets, wages are already bid up until they just equal the marginal value of labor to the firm; therefore if a minimum wage in a perfectly competitive market rose above the marginal value of labor, economic theory predicts that it would lead to a reduction in hours or jobs. But when labor markets are not perfectly competitive or when a monopsonistic firm reduces wages and employment below the levels that would prevail in a competitive market, there is scope for a higher minimum wage to raise both wages and employment.

Beginning in the early 1990s with the influential work of Card and Krueger (1995), research began to find evidence of minimum wage increases that were not accompanied by job loss. Surveys of the minimum wage literature since then show the estimated employment effects are mostly close to and centered around zero (Belman and Wolfson 2014).8 This research has spurred many economists to question the conventional wisdom that labor markets are generally competitive and demonstrated that minimum wage increases can lift wages without impacting employment levels (Ashenfelter, Farber, and Ransom 2010). (p. 9)

The CEA is giving here the well-known result that a skillfully set minimum wage, finely tuned to local labor market conditions, can increase wages and employment in a monopsonistic labor market. But it's a big reach from that to the conclusion that an increase in the minimum wage will have no harmful effect on employment. The CEA report makes no mention, even if only to disagree, of the work of one of the leading experts on the effect of minimum wages on employment, David Neumark. In a December 2015 report from the San Francisco Federal Reserve Board, Neumark wrote:
How do we summarize this evidence? Many studies over the years find that higher minimum wages reduce employment of teens and low-skilled workers more generally. Recent exceptions that find no employment effects typically use a particular version of estimation methods with close geographic controls that may obscure job losses. Recent research using a wider variety of methods to address the problem of comparison states tends to confirm earlier findings of job loss. Coupled with critiques of the methods that generate little evidence of job loss, the overall body of recent evidence suggests that the most credible conclusion is a higher minimum wage results in some job loss for the least-skilled workers--with possibly larger adverse effects than earlier research suggested.

Also, here's where the aforementioned Adam Ozimek makes a devastating point in his critique:
Fourth, the CEA report points to the minimum wage literature as evidence of monopsony power. Leaving aside the debate over whether the minimum wage reduces employment (I say yes, the report says no) the literature clearly shows that the minimum wage increases prices. As Daniel Aaronson and Eric French have pointed out, the monopsony model implies that the minimum wage should increase employment and output, thereby decreasing prices. That prices rise is inconsistent with the monopsony model.

The CEA did not look hard to find evidence, again making this look like not just an economic but also a political document.

Back to Ways Around the Efficiency Problem

The CEA report:

As explained by Weil (2014), firms have increasingly been able to reduce labor costs through outsourcing and subcontracting, which frees them from internal equity constraints. (p. 10)

Exactly. As I noted in Part II of my critique, this evidence contradicts the CEA's report that monopsonists don't compete aggressively for labor. To the extent they do what Weil says, they reduce the inefficiency problem due to monopsony.

Rising Market Concentration

The CEA argues that rising market concentration in particular industries facilitates collusion. All other things equal, that's correct. Two things to add, though. First, the CEA says little about what led to rising market concentration. Does it occur to the CEA writers that when regulation increases, the "economies of scale in compliance" [I have written about that here and here] disproportionately hurt small firms? They don't mention it. Second, the CEA writes, "Indeed, evidence of rising market concentration and monopoly-style profits is especially strong in the health-care and technology sectors." (p. 10) Health-care sector. Hmmm. Has anything happened in the health-care sector in recent years that might have led to higher concentration? The CEA elsewhere mentions the Affordable Care Act, aka Obamacare, positively. Does that factor in here? They don't say.

The Role of Regulation

The CEA plays a strong hand in noting the damaging effects on mobility of occupational licensure and land-use regulations:

There are several reasons to suspect that the downward trend in labor market dynamism is due to rising costs of switching jobs. One is that this trend has occurred alongside upward trends in regulatory barriers that impede worker mobility (Davis and Haltiwanger 2014; Furman and Orszag 2015). Relative trends in housing prices and construction costs suggest that land-use regulations have become more restrictive in recent decades (Glaeser, Gyourko and Saks 2005). Excessive regulations could explain rising housing prices in a large and growing set of cities (Gyourko and Molloy 2014), which in turn can make it hard for workers to move to where the best jobs are.

The past five decades have also seen a strong upward trend in the prevalence of occupational licensing requirements (Figure 4); during this time, the share of U.S. workers needing a license to do their job has grown roughly fivefold (Kleiner and Krueger 2013, CEA, Department of Labor, and Department of the Treasury 2015). CEA analysis shows that much of this increase has been due to an expansion of licensing into new professions, which may have negatively affected many lower-income individuals for whom the cost of obtaining a license can be especially onerous (CEA, Department of Labor, and Department of the Treasury 2015). The growth in occupational licensing has likely been restricting employment options and may be reducing bargaining power for less skilled workers. But further, because of the variation in licensing regulations across States, their increased prevalence also reduces geographic mobility for a growing number of workers in licensed occupations (Kleiner 2015). (p. 11)

Well done.

The Role of Unions

The CEA notes the huge decline in private-sector union membership in the last few decades (down to 7 percent), and argues that that is a bad thing:

Research suggests that declining unionization accounts for between a fifth and a third of the increase in inequality since the 1970s (Western and Rosenfield 2011). (p. 13)

I'm skeptical about the effect on inequality. Basic economics says that giving unions monopoly power (which is what the CEA implicitly advocates if it is defending U.S. labor law) would have two competing effects on inequality: (1) the one the CEA focuses on, which is that many workers get paid somewhat more, reducing the gap between their income and that of owners of capital, and (2) the one the CEA says nothing about: if the higher wage negotiated by unions causes employers to hire fewer people (that is, if, the monopsony the CEA posits is not strong), some of those not hired cause wages to fall in the sectors they go to. You might argue that I'm begging the question here--and I am. But the point is that the CEA's explicit claim that union power offsets monopsony power is just that: a claim, and a claim that the CEA does not support with evidence.

Moreover, unions notoriously reduce labor mobility, which, the CEA admits, is one of the key factors in monopsony. The seniority wage structure that unions bargain for means that once workers get union jobs, they are less likely to leave them voluntarily the longer they stay--because the more they have to lose.

Also, the aforementioned Adam Ozimek is worth quoting here:

The CEA paper also recommends more unionization as a solution. While unions can be efficient in the face of monopsony power, increased unionization won't necessarily occur at the employers with monopsony power. Indeed, the literature consistently shows that unionization decreases job growth at the firm level. This undermines the CEA's conjecture that unions may deliver "even more efficient levels of employment."

Back to the Minimum Wage

The CEA writes:

The Federal minimum wage has also provided a check against monopsony wage setting in the past--especially among the lowest earners, who are often the most vulnerable to wage-setting power by employers. In a trend that parallels the decline in unions, however, the real value of the Federal minimum wage has declined 24 percent since its peak of $9.55 (in 2015 dollars) in 1968, eroding its ability to protect those workers with the fewest options. (p. 13)

It's not at all clear that the lowest earners are "often the most vulnerable to wage-setting power by employers." The lowest earners are typically the least skilled and the least skilled often have many options. The options might be lousy options from your or my point of view. But the point is that if they have many lousy options, they are not vulnerable to monopsony. Also, the last sentence quoted above is ironic. It is precisely the minimum wage that takes away, and sometimes destroys, options of the least skilled--by pricing them out.

Again, this is getting overly long. Part IV is next.

Comments and Sharing

CATEGORIES: Labor Market , Regulation

COMMENTS (4 to date)
Thaomas writes:

The CEA by focusing on the effects on employment of a higher minimum wage is, perhaps unfortunately, only engaging in the current economic debate -- is the elasticity of demand for labor greater than zero or not. By doing so they fail to engage in a more important issue, why, given the near zero estimate of the elasticity, what are the costs and benefits of using a minimum wage, rather than other policies that do not affect the cost to the employer, to increase the incomes of low paid workers such as a higher EITC.

pyroseed13 writes:

The entire report reads like a political document designed to lend credence to a very bad idea. Do these economists really believe that labor market monopsony is that widespread?

Don Boudreaux writes:


I love this series you're doing.

But let me think aloud (or 'a-write') here: it's not clear that Adam Ozimek is correct that a minimum wage in the face of genuine monopsony power will always "increase employment and output." It will do so under the conventional version of that model - that is, the version in which the monopsonist doesn't wage discriminate. But the very nature of monopsony power means that employers have the power to wage discriminate. (For reasons that I'll not get into here, I think it likely that a monopsonist in a labor market has even more power to wage discriminate than does a monopolist in an output market have power to price discriminate.) To hire an additional worker of type L does not require that that employer raise the wages of its existing workers of type L.

So consider the extreme case of perfect wage discrimination by an employer with monopsony power over low-skilled labor. The final such worker hired will be paid the value of his or her marginal product, but all of the other such workers will be paid less. And, of course, the quantity of such labor employed will be the competitive amount.

In stage one, a perfectly set minimum wage for this employer will (1) contrary to the standard competitive-model prediction, cause no decrease in employment; and (2) contrary to the standard monopsony-model prediction, cause no increase in employment.

Now let's move to stage 2 and ask what happens to this employer's output as a result of this minimum wage. (Remember, I'm thinking aloud here.) The employer's costs of producing the same quantity of output as before clearly rise because this employer must pay more to some of its workers (because the wages paid to all of his inframarginal low-skilled workers are made higher by the minimum wage). If we assume (unrealistically) that this employer does nothing at all to work his low-skilled workers harder or to substitute now relatively lower-cost machines for some of his workers, this employer's total costs rise by the full amount of the extra wages he must pay.

If this employer has no monopoly power in the output market, then this employer will eventually go out of business or find some way to reduce its output. During stage 2, prices in the output market will rise, causing the quantity demanded of the output to fall. The result will be reduced output of whatever good or service here is supplied to the output market by this monopsonistic employer.

So unless this employer is both a monopsonist and a monopolist whose costs have not risen to fully absorb or to dissipate its monopoly profits, if this monopsonistic employer perfectly wage discriminates the effect of even a perfectly set minimum wage seems eventually to be reduced employment of the kinds of low-skilled workers over which this employer has monopsony power.
Perhaps my above reasoning is flawed. Or if not flawed, perhaps it doesn't hold at all if wage discrimination is less than perfect. Those are issue that remain cloudy at the moment in my mind.

David R. Henderson writes:

@Don Boudreaux,
Your reasoning is not flawed. It is excellent. It also tracks what I said in Part II of this series. I pointed out that the CEA itself admitted that employers figure out ways of segmenting labor markets to pay different wages to different groups of workers.

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