Monopsony has a monopoly on ambiguity and sexing up search frictions as exploitation too

I’d go beyond Kuhn to argue Manning’s excellent book should be titled “Random matching with ex-ante wage posting in motion”

The Nobel Lecture: Equilibrium in the Labour Market with Search Frictions

Tattoos and job matching

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Information costs in the labour market

Every worker, even the low-paid worker, is alert to their opportunities and take the best jobs that come to their notice but it is gaps in their information is the sand in the wheels of this search. As Manning (2005) observed in his superb Monopsony in Motion:

That important frictions exist in the labor market seems undeniable: people go to the pub to celebrate when they get a job rather than greeting the news with the shrug of the shoulders that we might expect if labor markets were frictionless. And people go to the pub to drown their sorrows when they lose their job rather than picking up another one straight away. The importance of frictions has been recognized since at least the work of Stigler (1961, 1962) (Manning 2005, p. 4).

The left has a certain view of how the labour market works and how to best move workers into better paying jobs. Standing against this are arguments that it is a want of information rather than weak bargaining power is what slows workers down from moving to a better job. As Stigler (1961, 1962) argued, information is costly to obtain in the labour market:

No worker, unless his degree of specialization is pathological, will ever be able to become informed on the prospective earnings which would be obtained from every one of these potential employers at any given time, let alone keep this information up to date. He faces the problem of how to acquire information on the wage rates, stability of employment, conditions of employment, and other determinants of job choice, and how to keep this information current (Stigler 1962, p. 94).

The left accepts that low-paid workers respond actively to news of better paying job opportunities. They do this by arguing that a living wage improves the quality of recruitment pools. More workers apply for the living wage vacancies on the news of a living wage policy. Fewer employees quit and they work harder in response to a living wage.

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Activists should mind how they go by stressing an inequality of bargaining power but also letting through the door even one market discipline such as a sensitivity of wage offers and profits to job turnover rates:

Let us consider the extreme case of highly specialized, non-versatile labor. If we consider (a) the continuous replacement of personnel who gradually leave through competing employment openings, retirement and death, and (b) (in an expanding industry) the recruitment needed for expansion, we must recognize that the probability of the workers’ exploitation is remote. The observable labor turnover between firms suggests indeed that collusive action to reduce the price of labor has virtually never been regarded as profitable (Hutt 1973, p. 4).

But not every worker knows there are better paying options which may be even just a few steps away from their current job. Information costs are a better explanation than pinning everything on an inequality in bargaining power. This is because information costs have a profound impact on labour market workings (Stigler 1962; Alchian 1969; Alchian and Allen 1967, 1983). For unequal bargaining power to keep the wages of the low-paid down, collusion must succeed between a great many employers recruiting across many industry and occupational labour markets (Hutt 1973, Alchian and Allen 1983).

More insight is gleaned from the fact that job seekers do not initially know the location of suitable vacancies, the wages for various skills, differences in job security and other factors. They must find this knowledge, keep it current and forecast whether better vacancies may open soon. Employers must learn the location, availability and asking wages of suitable applicants.

Long-term contracts arise to share risks and curb opportunism over sunken investments in specialised human capital. These factors lead to queues, unemployment, spare capacity, layoffs, shortages, inventories and non-price rationing in conjunction with wage rigidity (Alchian 1969; Alchian and Allen 1967, 1983). Labour market analysis must stay within McCloskey’s maxim that

Every piece of economic analysis is not complete until everyone is earning only normal profits, or at least the analyst can identify a reason why not (McCloskey 1985).

The labour market has good and bad jobs, the jobs that can pay more than or less than the going rate, resulting from the costs of job search and matching. These good and bad jobs arise from the element of chance in every job search and job match rather than betting it all on an enduring employer conspiracy to keep wages down. Some workers are paid less than the going rate because they are down on their luck rather than under the thumb.

The revolution in hiring practices

Times have changed since a 1930s Philadelphia dockyard foreman hired day labour by throwing apples over the front gate (Jacoby 1985, p. 13). Whoever waiting outside caught them passed the physical and the initiative test too. In the 1960s, Ford had a waiting lounge at its factory gate:

“If we had a vacancy, we would look outside in the plant waiting room to see if there were any warm bodies standing there. If someone was there and they looked physically OK and weren’t an obvious alcoholic, they were hired” (Murnane and Levy 1996, p. 19).

These rather casual approaches to the screening of applicant quality and job fit are well behind us.

There has been a revolution in how private and public employers husband employees at all pay grades. Human resource management gained ground in the 1980s at the expense of old style personnel management (Acemoglu 2002). Strategic human resource management stresses rigorous selection and recruitment, more training at induction and on the job, more teamwork and multi-skilling, better management-worker communication, the encouragement of employee suggestions and innovation, and common canteens and uniforms as unifying status symbols (Lazear 1998).

Modern human resource management strives for a single unified organisational culture made up of highly committed, capable workers who pull together at their own initiative (Baron and Kreps 1999). This pays because, for example, the share prices of firms rise on the announcement of family-friendly policies and the winning of good employer awards (Arthur and Cook, 2004, 2009).

Who haggles over wage offers and why?

The strength of alternatives to no agreement drives wage bargaining as Alchian and Allen explain:

An important truth is that employers compete against other employers, and employees against other employees-not employees against employers, as folklore says. It is the availability of higher-valued alternatives, not the ability to bargain collectively, that increases bargaining power (Alchian and Allen 1967, p. 328).

The side with more outside options and a stronger ability to credibly commit to a specific wage offer wins the larger share of the split (Manning 2005; Cahuc and Zylberberg 2004; Lazear 1998).

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Those searching for new jobs while on-the-job play a better hand than the unemployed (Manning 2005). Concerns about workers not holding their own in this wage bargaining date back to Adam Smith:

… in the long run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate (The Wealth of Nations).

Calls for a minimum wage arise partly out of concerns over who has the upper hand in bargaining:

… labour is often sold under special disadvantages arising from the closely connected group of facts that labour power is ‘perishable’, that the sellers of it are commonly poor and have no reserve fund… The want of reserve funds and of the power of long withholding their labour from the market is common to nearly all grades of those whose work is chiefly with their hands.

But it is especially true of unskilled labourers, partly because their wages leave very little margin for saving, partly because when any group of them suspends work, there are large numbers who are capable of filling their places (Marshall 1920).

Take-it-or-leave-it wage offers are more common for lower paid vacancies (Cahuc, Postel-Vinay and Robin 2006). Employers who post the going rate for lower-paid vacancies saves transaction costs for both sides of a more routine job match (Alchian and Allen 1967; Boeri and van Ours 2013).

The take-it-or-leave-it offer for a standard vacancy to be filled by similarly qualified job applicants may reflect where bargaining would have gone in any case and so saves that predictable journey. The market discipline on employers is posting an offer below the going rate attracts an inferior job applicant pool (Mortenson 2003; Boeri and van Ours 2013; Cahuc, Postel-Vinay and Robin 2006).

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A well-matched recruit is a valuable find and the better paid is the job, the more it is worth haggling over the spilt (Alchian 1969; Lazear 1998). One-third of workers bargain over the wage paid in a new job; only about 5% for blue collar workers haggle but 86% for knowledge workers make counter-offers (Krueger and Hall 2012; Brenzel, Gartner and Schnabel 2014; Brenčič 2012). The less skilled job seeker finds new jobs faster because they have less specialised human capital to match up with prospective vacancies than say a knowledge worker (Alchian 1969; Oi 1983, 1987: Lazear 1998).

Lower paid jobs entail less search and bargaining because there is less to haggle over; there is more variance in applicant quality and goodness of fit for higher paid vacancies so both sides search for longer and haggle more (Lazear 1998; Alchian 1969; Oi 1987).

The going rate for low skilled vacancies is common knowledge. Employers that post an inferior offer risks lowering the quality of their recruitment pools. It saves search costs for both sides to post the going rate (Alchian and Allen 1967; Lazear 1998). The rub is less skilled employees are laid-off sooner in downturns because less firm-specific human capital is lost for both sides of the job match (Oi 1962, 1983; Becker 1993).

Don Bordeaux was right! Monopsony is a great business opportunity

What would you do if you could cut your prices by 25% and still make a profit? Suppose you could pay your workers 25% more, recruit the best and brightest, still make a profit and greatly expand your business and bottom line?

A survey on monopsony power of employers by the Council of Economic Advisors at the White House suggests that this is so. Employers are paying up to 25% below the competitive wage.

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Source: COUNCIL OF ECONOMIC ADVIS ERS ISSUE BRI EF OCTOBER 2016, LABOR MARKET MONOPSONY: TRENDS, CONSEQUENCES, AND POLICY RESPONSES .

Don Bordeaux has repeatedly pointed out that monopsony power is a marvellous business opportunity:

whenever I encounter the assertion that minimum-wage legislation is justified because employers of low-skilled workers allegedly possess monopsony power, I point out to those who assert the existence in reality of monopsony power as a reason to impose a minimum wage that their assertion implies the existence of profit opportunities for anyone who enters the market to hire away these allegedly underpaid workers.

So I ask those who assert that monopsony power is real and relevant to start their own businesses to give solid evidence of the strength of their belief.

The best and brightest in many occupational labour markets underpaid by a 25% according to the literature survey by the Council of Economic Advisors. This means a budding entrepreneur could recruit a top-quality labour force and still make a big profit by paying a bit more than the current wage in his industry

Just in case you are a novice at starting a business, Bordeaux was good enough to identify a consultant willing to provide advice on how you can seize this  resistant, no but untapped opportunity for long run super-normal profits:

I know a very successful and savvy businessman in California, Mike Long – a man of enormous integrity and experience – who stands ready to share with you his time, expertise, and counsel in order to guide you in starting and operating your own businesses.  All you need do is to supply some of your own seed capital – say, a minimum of $25,000 – and Mike will help guide you to launch and run your business in order to take advantage of the profit opportunity that your identification of monopsony power implies is available for the taking.

Mike can even share with you his knowledge of how to get from the capital markets any additional financing you might need.

Almost every market failure is a business opportunity including market power of employers over workers as Bordeaux explains

In short, monopsony power in labor markets keep workers underpaid.  With all those underpaid workers out there – and because there are no government-enforced prohibitions on starting companies that employ low-skilled workers – a true believer that monopsony power is a prevalent reality can profit by exploiting this pool of underpaid workers.  Yet they do not.  They remain in their faculty offices writing papers and issuing commentary.  I continue to insist that this inaction is sufficient evidence against the proposition that monopsony power prevails in the market for low-skilled workers – and, hence, conclusive evidence that the higher the minimum wage, the worse are the job prospects of low-skilled workers.

If an academic tells you that his research finds that the price of Acme Corp. stock – a stock traded, say, on the NYSE –  is too low, what would be the first question you ask this scholar?  The first question I would ask him is “How much of that stock are you buying?”  If the scholar tells me “none,” or looks at me befuddled as he explains that he’s an academic and not an investor, I would dismiss his research on this front.  That person, as I see him here, offers proof as good as it gets that he does not believe what he asserts.

Just as identifying systematically undervalued shares as an opportunity for critics of the efficient markets hypothesis to profit, those who believe the competition in the labour market is less than it should jump in and exploit those walkers for themselves.

They can assuage their consciousness by knowing that they are exploiting these workers by paying them more than the other exploiting employers currently do.This is no more than a variation of the argument that if workers are underpaid, they can establish a workers co-operative to buy out their employer, pay themselves more and still profit.

One of the curios of the monopsony argument is it was originally based on company towns exploiting the captive labour market in the old mining days.

Trouble is that modern research showed the company towns where the employer owned the houses and rented them to employees was a way of showing would-be recruits that they would not exploit them. Because the worker did not have to buy a house or sign a lease to go to the company town, he could quit at any time and not be trapped in a lease or mortgage that locked him into his current job. Tabarrok explains

On the one hand, this did mean that during a lengthy strike the firm could evict the workers from their housing. On the other hand, would you want to buy a house in an isolated town dependent on a single industry? Would you want to own a major asset that was likely to fall in price at the same time that you were likely to lose your job? Probably not.

Rental housing meant that workers had the freedom to leave town easily when better work opportunities were available elsewhere – i.e., it meant that the workers were less isolated from the national labor market than they would be if they owned their homes and were tied down to a single place and a single employer

What brought company towns to their knees were something as simple as the widespread ownership of an automobile. These days, employers have to offer large inducements to get workers to move to isolated places to work. That includes accommodation and various other premiums over the going rate in the industry.

Labour economics is falling to the same trap industrial organisation fell into in the mid-20th century when it encounters phenomena which  it has trouble explaining as Coase said at the time:

One important result of this preoccupation with the monopoly problem is that if an economist finds something—a business practice of one sort or other—that he does not understand, he looks for a monopoly explanation. And as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation, frequent.

Economists’ understanding of industrial organisation improved greatly when it started studying  contracting in greater detail, especially long-term contracting. Labour economists are doing the same when they consider search and matching as a better explanation of how the labour market works. The monopsony argument is fragile when closely examined as Kuhn said:

… as Manning himself acknowledges, if matching is balanced (which effectively amounts to constant returns to scale in the technology for recruiting new workers), all elements of monopsony disappear from the model and the neoclassical equilibrium again prevails: in the long run firms can expand without limit without needing to raise their wages.

Thus it is absolutely critical to the search-based monopsony model at the core of this book that there be diminishing returns to scale in the technology for recruiting new workers. In other words, for the theory to apply, firms must find it harder to recruit a single new worker the larger the absolute number of workers they currently employ.

Alan Manning wrote a great book called Monopsony in Motion: Imperfect Competition in Labor Markets but in a great review of it, Peter Kuhn said

The key point seems to be that the title Search Models with Ex-Ante Posted Wages in Motion, while considerably more accurate than Manning’s, is certainly less catchy.

Robert Lucas on the voluntary and involuntary unemployment distinction

Robert Lucas in a famous 1978 paper argued that all unemployment was voluntary because involuntary unemployment was a meaningless concept:

“The worker who loses a good job in prosperous time does not volunteer to be in this situation: he has suffered a capital loss. Similarly, the firm which loses an experienced employee in depressed times suffers an undesirable capital loss.

Nevertheless the unemployed worker at any time can always find some job at once, and a firm can always fill a vacancy instantaneously. That neither typically does so by choice is not difficult to understand given the quality of the jobs and the employees which are easiest to find.

Thus there is an involuntary element in all unemployment, in the sense that no one chooses bad luck over good; there is also a voluntary element in all unemployment, in the sense that however miserable one’s current work options, one can always choose to accept them.”

I agree that we all make choices subject to constraints. To say that a choice is involuntary because it is constrained by a scarcity of job-opportunities information is to say that choices are involuntary because there is scarcity. Alchian said there are always plenty of jobs because to suppose the contrary suggests that scarcity has been abolished.

Lucas elaborated further in 1987 in Models of Business Cycles:

A theory that does deal successfully with unemployment needs to address two quite distinct problems. One is the fact that job separations tend to take the form of unilateral decisions – a worker quits, or is laid off or fired – in which negotiations over wage rates play no explicit role.

The second is that workers who lose jobs, for whatever reason, typically pass through a period of unemployment instead of taking temporary work on the ‘spot’ labour market jobs that are readily available in any economy.

Of these, the second seems to me much the more important: it does not ‘explain’ why someone is unemployed to explain why he does not have a job with company X. After all, most employed people do not have jobs with company X either. To explain why people allocate time to a particular activity – like unemployment – we need to know why they prefer it to all other available activities: to say that I am allergic to strawberries does not ‘explain’ why I drink coffee.

Neither of these puzzles is easy to understand within a Walrasian framework, and it would be good to understand both of them better, but I suggest we begin by focusing on the second of the two.

F A Hayek – Unemployment And The Free Market

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