Tuesday, March 19, 2013

Monopsony In Labour Markets

I once characterised employer hiring as similar to a monopsonistic market – I’m somewhat chuffed that I’m hardly alone in thinking that way (excerpt):

Where's the monopsony?

...There is in economic theory a set of circumstances, however, under which an increase in the minimum wage might raise employment. If an employer has a market largely to itself--if it has monopsony power--then it will both pay its workers less than their productivity warrants and not hire enough workers to be at the most efficient level of employment. Raising the minimum wage would then both increase pay and induce more workers into the labor market, hence increasing employment. If government could nail the minimum wage to the marginal revenue product of the least productive workers, the minimum wage could produce a first-best outcome--one where pay and employment levels were efficient.

For the argument to work, the demand for labor needn't be perfectly monopsonistic, but rather less than perfectly competitive. The fact that wages and labor productivity seem to have less and less to do with each other is evidence that the demand for labor is not competitive, but it would be nice to have further, detailed evidence of the industrial organization of labor demand.

That’s a nuance I never dreamed of – that a minimum wage could in fact be more efficient than the market clearing wage. Just goes to show how an undergraduate neo-classical education can close one’s mind to possibilities.

There still remains more than a few practical problems though – if you set a floor for labour prices, in the event it is above the market clearing wage how can you tell what the right level of the minimum wage should be? MRP is a nice concept, but it won’t tell you what the wage rate should be in any particular industry. A flat rate across the whole economy means that the minimum wage might be efficient for some segments, yet inefficient in others.

More problematically, which measure of productivity should you target (gross, net, value-added)? And what kind of mechanism should be used to adjust the minimum wage to changes in productivity?

I think I need to leave such questions to much better economists than I.

(H/T Mark Thoma)


  1. Interesting! but wouldn't that require the next level detail of minimum wage of each and every job category?

    1. Exactly right - a flat minimum wage rate would bulldoze over those differences, which means it won't be correct for some or most. The flip side is that trying to have multiple minimum wage rates would be an administrative and statistical nightmare.