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The Myth of Monopsony Power: Some Evidence

Regular readers of this blog know that I believe claims of the meaningful existence of monopsony power in the market for low-skilled workers in America to be ludicrous on their face.  These regular readers also know that even if such widespread monopsony power did exist, it is only a necessary and not a sufficient condition for minimum wages not to reduce the employment prospects of some low-skilled workers.  For minimum wages to work as promised by those who assert that minimum wages will not destroy some jobs for low-skilled workers, the employers of low-skilled workers must posses both monopsony power over low-skilled workers and monopoly power in their output markets.  (See, for example, these observations by Jim Buchanan and Don Dewey.)

Warren Meyer has a beautiful and clear post today making the point more clearly and more forcefully than I have ever made it.

So let’s consider a company paying minimum wage to most of its employees.  At least at current minimum wage levels, minimum wage employees will likely be in low-skill positions, ones that require little beyond a high school education.  Almost by definition, firms that depend on low-skill workers to deliver their product or service have difficulty establishing barriers to competition. One can’t be doing anything particularly tricky or hard to copy relying on workers with limited skills. As soon as one firm demonstrates there is money to be made using low-skill workers in a certain way, it is far too easy to copy that model.  As a result, most businesses that hire low-skill workers will have had their margins competed down to the lowest tolerable level.  Firms that rely mainly on low-skill workers almost all have single digit profit margins (net income divided by revenues) — for comparison, last year Microsoft had a pre-tax net income margin of over 23%.

As a result, the least likely response to increasing labor costs due to regulation is that such costs will be offset out of profits, because for most of these firms profits have already been competed down to the minimum necessary to cover capital investment and the minimum returns to keep owners invested in the business. The much more likely responses will be

  1. Raising prices to cover the increased costs. This approach may be viable competitively, as most competitors will be facing the same legislated cost pressures, but may not be acceptable to consumers

  2. Reducing employment. This may take the form of stealth price increases (e.g. reduction in service levels for the same price) or be due to a reduction in volumes caused by price increases. It may also be due to targeted technology investments, as increases in labor costs also increase the returns to capital equipment that substitutes for labor

  3. Exiting one or more businesses and laying everyone off. This may take the form of targeted exits from low-margin lines of business, or liquidation of the entire company if the business Is no longer viable with the higher labor costs.


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