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An Empirical Conclusion

Posted By Don Boudreaux On October 29, 2013 @ 7:07 am In Data,Reality Is Not Optional,Seen and Unseen,Work | Comments Disabled

Aaron the Aaron (my angry e-mail correspondent) dislikes my argument that employers of low-skilled workers do not have monopsony power.  (The argument that such employers do have monopsony power is crucial for the more sophisticated proponents of legislated minimum wages because, absent such power, a hike in the minimum wage would indeed price many, or at least some, low-skilled workers out of jobs – a consequence that defenders of minimum wages understandably do not wish to defend.  Here’s David Henderson’s verbal explanation of the consequences of monopsony power [1].)

Specifically, Mr. the Aaron objects to my claim that, because there are no government-enforced prohibitions on the hiring of low-skilled workers, anyone who truly believes that monopsony power in this labor market exists should start a company that uses low-skilled workers.  Mr. the Aaron calls my claim “not practical” and “comical.”  But I stand by my claim.  The researcher who found genuine monopsony power would, by starting his or her own company, earn profits and directly improve the economic lot of low-skilled workers.  The reason, again [2], is that the exercise of monopsony power by existing employers keeps the prevailing wage lower than the value of what workers produce, at the margin, for their employers.

In short, monopsony power in labor markets keep workers underpaid.  With all those underpaid workers out there – and because there are no government-enforced prohibitions on starting companies that employ low-skilled workers – a true believer that monopsony power is a prevalent reality can profit by exploiting this pool of underpaid workers.  Yet they do not.  They remain in their faculty offices writing papers and issuing commentary.  I continue to insist that this inaction is sufficient evidence against the proposition that monopsony power prevails in the market for low-skilled workers – and, hence, conclusive evidence that the higher the minimum wage, the worse are the job prospects of low-skilled workers.

If an academic tells you that his research finds that the price of Acme Corp. stock – a stock traded, say, on the NYSE –  is too low, what would be the first question you ask this scholar?  The first question I would ask him is “How much of that stock are you buying?”  If the scholar tells me “none,” or looks at me befuddled as he explains that he’s an academic and not an investor, I would dismiss his research on this front.  That person, as I see him here, offers proof as good as it gets that he does not believe what he asserts.

And my confidence in my dismissal of his conclusion would be bolstered when, after he publishes his research in a prominent journal, he and his like-minded scholars continue to insist that the price of Acme Corp. shares is too low.  Why, I would wonder, are none of those greedy, profit-hungry Wall Street types – now blessed with ready access to this scholar’s research – not buying lots of Acme stock and, thereby, bidding up the price of this stock to its appropriate level.

Assertions of monopsony power – even of “dynamic monopsony power” (which is the term used by David Card and Alan Krueger and others who champion their work [3]) – are simply unbelievable if the very people who make such assertions take no steps personally to profit from their discovery.  They have, after all, discovered (if they are correct) an unexploited profit opportunity – and yet they let it go unexploited.

Yes, yes, I know (because I’m one of them with these very traits) many academics are too inept, too lazy, and hopelessly dimwitted about business and financial realities actually to do anything practical such as start a company or even to profitably convey profitable advice to any of the legions of able entrepreneurs and businesses who are able and willing to exploit prevailing profit opportunities.  So the inaction in the real world of these academics might reflect only their laziness or ineptness in practical matters.  But then why should anyone take advice offered by these academics on how government can intervene to ‘correct’ the ‘imperfections’ allegedly found by these academics?  Surely, an academic so inept that she cannot persuade profit-hungry private investors to make fortunes based upon her scholarly findings is not to be trusted to persuade government to act as if her findings are correct.

So here’s my empirical finding – one that I believe is rock-solid.  The fact that nearly all economists who claim to believe in the prevalence of any sort of monopsony power in the U.S. labor market make no efforts personally to exploit this alleged profit opportunity – either directly or by somehow selling their advice to experienced entrepreneurs – is real and powerful empirical evidence that such monopsony power does not exist.  I have a high degree of confidence in this empirical finding.

To act on policy advice from academic researchers who insist on the reality of monopsony power but who do nothing other than offer policy advice to governments is as foolish as acting on stock tips from a self-proclaimed investment expert who himself does not buy the stocks he recommends.

WONKISH UPDATE: Bill Woolsey offers an important perspective on my argument above [4].  He does so, appropriately, by comparing monopsonistically competitive equilibrium to monopolistically competitive equilibrium.  I have serious – and have long had serious – doubts about the internal coherence and usefulness of the monopolistic-competition model.  I believe that it is seriously flawed.  I will post later on my objections – but not now, as I just returned from a trip and must prepare to teach tonight.

But taking the monopolistic-competition and its analogous monopsonistic-competition models on their face, these models still do not salvage the case for minimum-wage legislation.  If government imposes a maximum output price in a monopolistically competitive market, the new, lower, legislated price is below average unit costs.  The firms cannot long last in the industry in this situation.  The reason is the “competition” part of monopolistic competition: all excess profits have been competed away even though the monopolistically competitive equilibrium price is above marginal cost.

Likewise in monopsonistic labor markets: a higher, legislated minimum wage causes firms to suffer losses because all of the excess profits once earned because the firms were able to purchase their low-skilled-labor inputs at wages below this labor’s marginal revenue product have been competed away on some other margin(s).  Therefore, forcing firms to pay more for each hour of low-skilled labor they hire imposes losses on firms.  Firms will attempt to minimize these losses by, say, increasing the ratio of capital-to-labor used in production or by demanding more output per hour from each minimum-wage worker.  Firms unable to adjust adequately will go bankrupt.  Whatever the final pattern of adjustments, it’s unlikely that an imposed minimum wage will not decrease the employment options of low-skilled workers.

Cafe readers might recall this Quotation of the Day from this past February in which Jim Buchanan discussed this very point [5].

But, as I say, I believe that a much more fundamental problem infects the monopolistic-competition and monopsonistic-competition models – flaws that only mask the destructive consequences of government-imposed price ceilings and wage floors.

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URL to article: http://cafehayek.com/2013/10/an-empirical-conclusion.html

URLs in this post:

[1] Here’s David Henderson’s verbal explanation of the consequences of monopsony power: http://econlog.econlib.org/archives/2013/02/the_minimum_wag_2.html

[2] again: http://cafehayek.com/2013/10/prove-that-you-believe-your-monopsony-model.html

[3] David Card and Alan Krueger and others who champion their work: http://rortybomb.wordpress.com/2011/09/01/guest-post-minimum-wage-laws-and-the-labor-market-what-have-we-learned-since-card-and-krueger’s-book-myth-and-measurement/

[4] Bill Woolsey offers an important perspective on my argument above: http://monetaryfreedom-billwoolsey.blogspot.com/2013/10/monopsonistic-competition.html

[5] this Quotation of the Day from this past February in which Jim Buchanan discussed this very point: http://cafehayek.com/2013/02/quotation-of-the-day-538.html

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