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A Note On Monopsony Power, Optimal Minimum Wages, and Policy Realism

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As regular readers of this blog know, the only theoretically plausible economic case for a minimum wage requires the existence of monopsony power in labor markets.  But as regular readers also know, (1) empirically, such monopsony in U.S. labor markets is extremely implausible [2] (even when monopsony is reckoned in its ‘new’ and ‘dynamic’ fashion [3]); and (2) such monopsony power is only a necessary, and not a sufficient, condition for minimum wages to ‘work [4]‘.

(This post is wonky, so the remainder of it is below the fold.)

Assume, contrary to reality, that monopsony in U.S. labor markets is real and that all above-normal profits yielded by such power somehow remain immune from being dissipated away by competition in output markets.  That is, assume that market conditions are such that it is possible in principle to use minimum wages to improve the well-being of all low-skilled workers without reducing any of these workers’ employment options.  What would an apolitical, scientific implementation of such minimum wages look like?

The chief realization is that there would be no single – no national – minimum wage.  Indeed, there would be no single minimum wage for even the smallest political jurisdiction.  Monopsony power is held by individual firms.  So each possessor of monopsony power – that is, each firm with monopsony power -would have imposed upon it, as a firm, a unique minimum wage.

The very nature of monopsony power means that each employer with such power over low-skilled workers is its own separate market for low-skilled workers.  Or, perhaps somewhat more mildly, each firm with monopsony power over low-skilled labor has not only a demand schedule for low-skilled labor that differs from that of the demand schedules of other firms, it also confronts a supply schedule for such labor that differs from any of the supply schedules confronted by other firms.  Further, obstacles prevent workers from smoothly moving from one firm to another.  (These obstacles are the source of each employer’s monopsony power.)  Therefore, only by happenstance will a minimum wage that optimizes the quantity demanded of labor, and the wage paid to labor, for firm A be the same as that which optimizes the quantity demanded of labor, and the wage paid to labor, for firm B.  Because the optimal minimum wage for monopsony firm A will almost certainly differ from the optimal minimum wage for monopsony firm B, a minimum wage that is optimal for firm A will, if imposed also on firm B, either cast some of firm B’s workers into the ranks of the unemployed or fail to cause firm B to increase its employment of low-skilled workers sufficiently to achieve optimality.

The larger point is that all the talk of monopsony power and of how the alleged reality of this power justifies government imposition of a minimum wage (or of more locally set minimum wages) suffers a deep flaw.  Even if monopsony power were widespread and the excess profits that it yields are miraculously not competed away in output markets, the scientific case for government imposition of minimum wages requires that an additional condition hold, namely, that government set a unique minimum wage for each employer with monopsony power – implying that government be able not only to objectively determine the optimal minimum wage for each of the (presumably) many employers with monopsony power, but also be able to be counted on to implement such wages apolitically.

Only the most dreamy-eyed political romantic would suppose that government officials can be trusted both to acquire such detailed firm-level information and to use this information apolitically.

But matters get yet more complicated once the dynamism of the global economy is taken into account.  With consumer demands frequently shifting, with new market opportunities always opening, and with new production techniques regularly becoming available, the optimal minimum wage for each employer with monopsony power changes over time – perhaps monthly or weekly (or even daily).  If, for example, the demand for firm A’s output falls tomorrow, the optimal minimum wage for firm A also likely falls.  If under these circumstances the state fails to lower firm A’s minimum wage, this failure will cause some workers to be unemployed.

I’ll likely have more to say about additional problems with such optimal minimum wages in a later post.  But without saying anything further here, it’s already clear that to assume that government has the practical ability (forget the willingness) to impose minimum wages that truly are economically optimal for low-skilled workers is to assume that which is too unrealistic to take seriously.  Not only is a nation-wide minimum wage absurdly unlikely to be optimal, any minimum wage – no matter how ‘local’ –  that isn’t set at the level of the individual firm is so unlikely to be optimal as to be worthy of outright rejection.  And the probability of the state accurately setting unique firm-level minimum wages – and adjusting these minimum wages through time as input- and output-market conditions change – is more minuscule still.

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