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The Ripple Effect and Monopsony Power

Posted By Don Boudreaux On March 6, 2014 @ 6:55 am In Seen and Unseen,Work | Comments Disabled

“A student” (that’s this anonymous person’s e-mail moniker) sent me this CNN report [1] on raising the minimum wage.  ”A student” – who calls himself or herself “proudly progressive” – requests my reaction specifically to this passage:

When there’s a minimum wage increase, some small business owners will raise the pay for most, if not all, hourly workers in order to preserve their wage structure and retain quality employees.

This argument is common; it’s a species of the “ripple-effect” argument.  One version of that argument (which is not the one on display here) is that some labor-union contracts tie their members’ hourly wage rates to some multiple of the federal minimum wage (or so I’m told).  If indeed such contracts exist, then under them a hike in the federal minimum wage will automatically trigger – by contractual stipulation – hikes in the wages of those unionized workers whose hourly wage rates are contractually tied to the federal minimum wage.

I have nothing to say about this union-contract ripple effect other than to point out that it perhaps supplies one hint for why labor unions are so keen on raising the federal minimum wage.  But I have no knowledge of the prevalence of such contract terms or of any their details.

In contrast, the alleged ripple effect discussed in the CNN report is a competitive market phenomenon.  Employers who must pay their lowest-paid workers higher wages when the minimum wage is raised will, under this theory, raise also the wages of some or many of their higher paid employees in order to (as the CNN report puts it) “preserve their wage structure and retain quality employees.”  That is, even though employers are not legally required to hike the wages of these higher-paid employees, competition to retain employees prompts employers nevertheless to hike those wages.

I do not doubt that some such “ripple effect” wage hikes occur.  Within firms employees do care about the relative-wage structure.  But I do doubt the prevalence of such ripple effects.  If employers must pay higher wage rates not only to their lowest-paid workers but also to some or many of their higher-paid workers, the costs to employers of a higher mandated minimum wage are greater than those costs would be if a hike in the minimum wage required them to raise the wages only of their lowest-paid employees.  All but the most naive proponents of the minimum wage must admit that at some point employers cannot simply absorb these higher labor costs or simply pass them all along in the form of higher prices charged to their customers.

That is, at some point all but the most naive minimum-wage proponents must admit one of two things.  If the ripple effect exists, it must destroy some jobs.  (Machines don’t care what other machines or workers are paid.)  Or the ripple effect is not as prevalent as naive analysis supposes it to be: a higher minimum wage will compress wage structures rather than ratcheting all wages up.

One other thought.  If this ripple effect is real – that is, if employers in reality are obliged by competitive pressures to respond to a hike in the minimum wage by raising the wages of some or many of their higher-wage employees – then this fact is further evidence against the claim that monopsony power infects labor markets.  If employers are obliged by competitive market forces (in response to a hike in the minimum wage to $10.10) to raise wages of employees making, say, $11.00 per hour, that is evidence that employers have no monopsony power over these higher-paid workers.  Employers with monopsony power over these higher-paid workers would simply tell these workers to deal with the fact that some other employees’ wages have risen.  Employers would raise these higher-paid employees’ wages only if these employees will quit if their wages are not raised.  Employers whose workers will quit under such circumstances cannot plausibly be said to have monopsony power over such workers.

So unless proponents of the monopsony-power hypothesis can plausibly explain that employers have monopsony power over only their lowest-paid workers (those paid the minimum wage) and not over workers any higher up on the wage scale, then any observed ripple effect would be evidence against the real-world prevalence of monopsony power.

Note that the absence of any observed ripple effect is not evidence that employers do have monopsony power over any of their employees.  The absence of any such ripple effect is more plausibly evidence that each employee is paid a competitive wage that reflects his or her productivity.

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[1] this CNN report: http://money.cnn.com/2014/01/14/smallbusiness/minimum-wage-hike/

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