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A Post of Its Own

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I’m honored that the thoughtful and wise Kevin Erdmann, of Idiosyncratic Whisk [2] fame, reads and occasionally comments at Cafe Hayek.

Here’s a slightly edited (for purposes of flow) back-and-forth between Kevin and me in the comments section of this post [3]:

KEVINI don’t understand, Don. It seems as though Acme has created monopsony power as the only owner of the massage chair. When other firms get the chair, wages will be bid up. I normally love your stuff, but I’m not sure I like this example.

DBx: What sense does it make to label as a source of monopsony power Acme’s creation of a contractual term that makes its employers better off? I understand that that’s the norm in economic theory, but it’s precisely the norm that gives rise to such confusing language (and, hence, confusing perspective) that I think to be a grave source of misunderstanding.

If Acme had NOT created the massage machine, its workers (you’ll agree) would be worse off than they are with the massage machine, even when these workers are paid 25 cents per hour less than before. It’s true that these workers would be even better off if and when other firms put in place such a machine (or its equivalent in value for workers). But it strikes me as deeply mistaken to label as a source of monopoly or monopsony power an innovation that, although it clearly makes everyone better off, does not yet result in the even more ideal situation that can conceivably result when every firm successfully matches the innovative firm’s initial innovation.

And, while you say that “Acme has created monopsony power as the only owner of the massage chair,” I say instead that “Acme has created and offered the massage chair as a means of purchasing from its workers the option of cutting their money wage. Acme is now offering its workers a better deal than it could offer before.” Surely calling that move by Acme a ‘monopsonizing’ one is, at best, misleading. Whatever ‘power’ the massage chair buys for Acme is voluntarily given to Acme by its workers in response to the massage chair.

It’s all part of bargaining. If workers respond positively to the massage chair (as in my example they do), far better – for both analytical and descriptive purposes – that Acme’s move to create the massage chair be modeled as a competitive rather than as a monopolizing (or monopsonizing) move. The workers’ options were only increased, and not in the least decreased, by Acme’s entrepreneurial move.

KEVIN: Thanks for your replies, Don. Those are all good points. And maybe I misunderstood the point of your original post.

But, it seems as though in your example, a legislated minimum wage of $9.85 could be enforced without causing a loss of employment, because Acme is earning excess profits from the massage innovation. That’s the kind of situation that proponents of MW imagine happening.

Of course, in the real world, Acme would probably have traded the excess hourly profits for market share, and the higher mw would cause a shift of employment back to there competitors, etc. And there would be a complex set of shifts that it would be hard to track.

At first glance, it just seemed like your example might be making the wrong point. But I might be nitpicking or misunderstanding the motive for the post.

I’m relieved that Kevin and I don’t disagree fundamentally, although perhaps – only perhaps – some disagreement does still linger at the fringes.

First, in my massage-machine hypothetical, it’s not the case (as I reason through it) that Acme necessarily is making above-normal profits.  Acme was led to create that machine because its labor costs were getting excessive.  With the massage machine Acme found a way to cut its labor costs by cutting its wages, but while this cost reduction might yield above-normal profits for Acme, at least for a while, it does not necessarily do so.  It could be that Acme’s innovative move to offer its workers massages with the machines, while being an innovation initially unique to Acme and one that’s not quickly matched by rival bidders for employees, simply enables Acme to avoid losses that would have threatened Acme’s survival (at least at its current scale of operation).  If this latter possibility were reality, then a hike in the legislated minimum wage would have caused Acme either to scale back its labor force or risk bankruptcy.

Second, even if Acme’s innovative worker-massage machines yielded for it above-normal profits, it does not follow that a hike in the legislated minimum wage would not cause Acme to employ fewer workers (or to work its workers harder, or some combination of both).  Acme’s shareholders and executives want every dollar of above-normal profit as much as they want every dollar of normal profit.  A government-imposed artificial hike in the cost of using one kind of input (for example, labor) will prompt Acme, regardless of how profitable it is, to seek out and to implement ways to keep its cost increase as small as possible.  Most obviously, it will search for opportunities to substitute capital for labor.  But other options to substitute out of labor are also likely available.

Third, note that I use the term “above-normal profit” rather than “excess profit.”  The term “excess profit” carries the implication that the profits are somehow unearned, unwarranted, unjustified, without function.  In fact, all the term means in this context is “above normal” – above the rate that is minimally necessary to keep this firm in business at its current scale of operation.  In my example, even if some or even all of the additional profit Acme earns as a result of its worker-massage machines is above normal, these profits are not “excess” in a plain-language understanding of the word “excess.”  Workers voluntarily respond favorably to these machines, and Acme did nothing to prevent rival employers from coming up with their own competitive responses.  So I see no reason to suggest that such profits are excessive.

Also, such profits are a – likely the – important spur to innovation [4].  If above-normal profits are an important spur and guide to innovation, calling them “excessive” strikes me as unwarranted.

(I do not mean here to be very critical of Kevin.  He uses the term “excess profits” here in exactly the way it is used in standard economic analysis.  It is this economic convention that I object to – that I believe to be misleading.)

Fourth, I have a fourth point to make, but I’ll save it for another, separate blog post.