Evidence Inconsistent With the Monopsony Theory of Minimum-Wage Legislation

by Don Boudreaux on July 25, 2015

in Work

Here’s a fact that I’d forgotten until I just now re-read James Sherk’s excellent June 25, 2013, testimony on the minimum wage before a U.S. House of Representative’s Committee:

Congress has not voted to raise the minimum wage when unemployment stood above 7.5 percent since the Great Depression ended.

This fact is inconvenient for those who endorse the theory that minimum-wage legislation is a means of addressing the problem of wages kept too low by monopsony power.  The reason is that the higher is the rate of unemployment, the greater are the prospects that employers will have genuine monopsony power which creates, at least in principle, a necessary condition (i.e., wages kept below the value of workers’ marginal products) for a hike in the minimum wage to increase the incomes of low-skilled workers without causing any job losses or other worsening of job prospects for such workers.

The higher the rate of unemployment, the worse are the prospects for dissatisfied worker Jones to find another job if she quits or is fired from her current one.  In other words, the higher the rate of unemployment, the more likely is low-skilled worker Jones not to quit her job – or to risk doing anything that puts her job at risk – even if her pay is below what her pay would be in a more competitive labor market.  Worker Jones’s employer, in short, might be said to have, and to exercise, some monopsony power over her.  So if the minimum wage is justified chiefly as a means of addressing extant monopsony power, we would expect that as the rate of unemployment rises, especially to recessionary levels, that the likelihood of the minimum wage being raised would also rise.

While the fact reported above by James Sherk doesn’t prove that there’s no positive relationship between the rate of unemployment and the likelihood of Congress voting to raise the minimum wage – perhaps such a positive relationship exists for rates of unemployment below 7.5 percent – the fact that no such vote has taken place during times of especially high unemployment (above a rate of 7.5 percent) remains a signal piece of evidence against the monopsony-power theory of minimum-wage hikes.

……

(Note to econometrically skilled young economists: I suggest an empirical study – or series of studies – to discover if there’s a statistically detectable relationship, be it positive or negative, between rates of unemployment and legislatures’ likelihood of raising minimum wages – with rates of unemployment being the independent variable.  Such a study can be time series or cross-sectional or both.  It can look also not only at the overall rate of unemployment, but also at the rates of unemployment of different age groups.  While my guess is that, if a relationship does exist between the unemployment rate and legislatures’ likelihood of raising the minimum wage, that relationship is negative, an interesting hypothesis is this one: as the rate of unemployment of unionized workers rises, legislatures become more likely to raise the minimum wage.  The reason would be to price out of the labor market lower-skilled workers who might be substitutes for unionized workers.)

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