Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 4 January 2018

Minimum Wages, Monopsony and Towns

Alan Manning has a very good article in Foreign Affairs about minimum wages. The impact of minimum wages on employment is a politically charged issue in economics, and so is similar in that sense to most of macro. With minimum wages, the battlefield is empirical. I often think of this battle when people accuse mainstream economics as being hopelessly neoliberal: it was mainstream economists (David Card and Alan Krueger) who first showed that the data did not conform to what Manning describes as Econ 101 economics, and other mainstream economists who have continued to find this result.

I think two conclusions can be drawn from the many studies that followed Card and Krueger. First, empirical work clearly shows plenty of examples where imposing or increasing minimum wages did not reduce employment. However few would argue that result will hold in all situations for all levels of the minimum wage. That is why, before George Osborne raised it, the UK minimum wage level was set by the Low Pay Commission, who tried to assess these issues. Perhaps the Commission became too cautious, but no doubt we will see more studies on the Osborne increase in due course.In my view another key issue future studies should address is whether increasing nominal wages has any impact on productivity.

Manning also makes a point about the limitations of minimum wages as a tool to deal with poverty. He points out that as “an hourly rate, the minimum wage on its own reveals little about the household income of those who earn it.” He suggests that minimum wages work well alongside earned income tax credits. Minimum wages can help prevent employers capturing part of tax credits by cutting wages in the knowledge that the state would make up the difference.

There are two main reasons why Econ 101 (first year undergraduate) economics gives the wrong answer on minimum wages: search and monopsony. Take search first. In the Econ 101 world no one celebrates getting a new job or worries about losing an existing one. One reason most people do both is search: it takes time and effort to find a new job. Equally it costs the firm money to recruit new people. That creates a zone around the Econ 101 wage within which variations in wages would not lead to job losses or people leaving. Where the actual wage is within that zone will depend on bargaining power between the worker and firm.

Monopsony is the situation where alternative employment opportunities for workers are scarce, which gives the firm the power to set wages below the perfectly competitive level of the standard Econ 101 model. (There is an element of search here too: the costs of moving location. These are much larger than the costs of looking for a job in your own area, particularly for families.) The classic example of monopsony is the town where there is just one major employer.

I suspect many labour economists regard monopsony in the labour market as something of a special case. That perception may need updating, argues Marshall Steinbaum here, drawing on recent work by him and coauthors for the US. They find “that most labor markets (as defined by occupation and geography) are very concentrated [few firms], and that this concentration has a robust negative impact on posted wages for job openings.” That is exactly what you would expect from monopsony: the fewer firms there are in a location, the less often vacancies occur, so the less these firms when suppressing wages have to worry that workers will quit.

The article considers a number of policy implications stemming from widespread monopsony that are worth reading. This could include, in the UK, improving rail communications into cities besides London. The one directly relevant to this post is that these results may help explain why minimum wages do not reduce employment. In the absence of minimum wages, relatively poorly performing firms may be able to shift the impact of poor performance from profits to wages. The minimum wage stops that happening. 

If monopsony is prevalent in large towns but not big cities, I couldn't help wondering if this might have something to do with the difference between towns and cities in the Brexit vote I mentioned in my last post. Support for Trump is also strong in the rural parts of the US, which is where Steinbaum et al find monopsony is prevalent. What this monopsony study suggests is that working conditions within firms are likely to be worse in towns than in cities. What impact might that have on voters? One response to worker exploitation in towns is for people to leave, as they do. For those who stay, an overriding concern might be the survival of firms within the town. This in turn could have an important impact on voter attitudes.  


  1. Employers cease employing more people when the marginal product of labour falls to the min wage / union wage or whatever. I.e. there are a HUGE number of potential sub min wage jobs out there.

    I suggest letting employers pay as low a wage as they like (with the state making up take home pay to socially acceptable levels), but limiting the time for which an employer can exploit that system in respect of a given employee. That would benefit some members of the dole queue, e.g. the ones who are keen to do SOMETHING rather than nothing. It would also benefit those looking for work experience.

    1. This is silly. Employers respond to higher wages by investing in equipment and training to increase productivity of workers. If there is no minimum, there is no need for investment to make workers more productive. This is obvious from observing employment in poor countries that lack minwage laws
      -jonny bakho

    2. I actually like your answer (let the state make up take home pay out of taxes), but your premise misses the point of the post. Firms hire at the point where the marginal revenue product of labor meets their marginal factor cost. In a monopsony, the marginal factor cost is higher than the wage.

  2. "The one directly relevant to this post is that these results may help explain why minimum wages do not reduce employment. In the absence of minimum wages, relatively poorly performing firms may be able to shift the impact of poor performance from profits to wages. The minimum wage stops that happening. "

    I'm not sure how to understand the first sentence in connection with the rest of the article? Did you mean "why minimum wages do reduce employment" ?

    1. No, it explains why minimum wages do not. Firms hiring from a monposonistic position do not hire where the marginal revenue of workers meets the wage, but at the lower quantity where marginal revenue product meets marginal factor cost (which is higher, because hiring an additional worker means raising the wage paid to all the previous ones, generally). So adding a minimum wage does not reduce employment like it would in perfect competition (just as a price ceiling applied to a monopoly does not necessarily reduce quantity)

  3. The most important factor that seems left out of minimum wage discussions is that labor's price is a price-within-a-price (a curve within a curve). Labor cost at McDonald's is 33% -- at Walmart 7% -- some big difference in how much labor can squeeze (the ultimate) consumer, isn't there?

    Another simple factor lost (I'm not assuming there's an easy way to measure it) is that labor might very well prefer two $15/hr jobs to three $10/hr jobs (etc., and so on).

    There is also re-circulation: the extra money that low income labor squeezes out of consumers will usually be spent proportionately more at lower paying businesses. Don't forget some higher paying jobs may be lost here.

    What we really need is to re-build labor union density back to 60's or even German levels. Free market can sort out labor's price much more efficiently. EITC no huge help overall -- shifts 1/2 of 1% of income while 40% of workforce under what we would like the minimum wage to be.
    * * * * * *
    When Democrats take over Congress, we have to institute mandatory union certification and re-certification elections at every work place (stealing a page from the Republican's anti-union playbook). Only practicable, quick way back. I would add the wrinkle of making the cycle one, three or five years -- plurality rules -- take a lot of potential rancor out of first time votes in some workplaces.
    * * * * * *

    Why Not Hold Union Representation Elections on a Regular Schedule?
    November 1st, 2017 – Andrew Strom

  4. Let setting of the minimum wage, if there has to be one, be devolved to Local Authorities or Combined Authorities.
    By what right should the populace of London by virtue of its size have more say over what a dude in the North-East can charge for his labour than the people of the North-East do over themselves?

  5. "In the Econ 101 world no one celebrates getting a new job or worries about losing an existing one. One reason most people do both is search: it takes time and effort to find a new job. Equally it costs the firm money to recruit new people. That creates a zone around the Econ 101 wage within which variations in wages would not lead to job losses or people leaving."

    Why not simply call it transactioin costs of hiring and getting hired that create an employment stickiness?

    This doesn't help regarding possible substitution by machines and it doesn't help regarding new hirings.

    The reasons I tell people about why minimum wage increases often don't matter for employment are different ones:
    (1) The employers often don't know the productivity of their employees - they have no metric. Nobody knows how much less turnover or how many more expenses a chemical plant will have if they reduce staff by one gate guard.
    (2) There's so much low end labour supply that companies hire at the price where the people take the job (this is determined by the private and public social net), which is often not anywhere near their productivity. The labour supply curve is nowhere near a steady curve or line - it's freaky near the low wage end. And it's often horizontal (or vertical if you draw the diagram the other way) near the typical minimum wage rates.
    There are also some special effects. Germany has a 420 € monthly limit on social insurance free jobs. There are lots of those helper jobs. An increase of the minimum wage means you can fit less hours into those 420 € - so many restaurants need another helper.

  6. If doubling everyone's minimum wage in the US to $15 is a good idea, one double everyone's wages? That is absolutely nothing special about the minimum wage regarding any of the arguments advanced as to why will not reduce employment much if a small increase is made. All the arguments are not special to the minimum wage be they efficiency wage or monopsony

    1. What's special about the low end of wages is the relevance of means testing welfare programs. The government effetively subsidises low wage work with when it pays the employee as well.
      A living wage as minimum wage largely eliminates this effect, as then the employers have to pay the employee what the employee needs for a living.

  7. I'm surprised not to see an attempt to incorporate efficiency wages in the analysis. Asymmetric information is pervasive, on both sides: employers don't know whether new hires will be conscientious, workers don't know whether a new employer will be competent and fair. This leads to a satisfactory account of wages (with bonuses) being set above the market-clearing level, and equilibrium unemployment. Now add minimum wages. A first sketch: the higher minimum wage adds to base pay, but not to overtime and bonuses. For the good workers who get these, overall pay does not rise significantly. Dud workers will get the higher base pay unless fired - but they are a small factor to most employers. So, shrug.

  8. For the US and Trump support in rural areas, the answer is simple: It's driven by racism. Multiple studies have borne this fact out. The people in these towns regularly and routinely vote against their own economic interests in support of racist politicians, with Trump being only the most extreme recent example to reach high office.

    Furthermore, much of the antagonism for policies that would help people with low incomes is cast in racist terms, in effect suggesting that if the government policy helps "those people", then it isn't worth doing.

    1. To what extent though is their hostility to non-whites a proxy for hostility to the big cities which rob them of their children?

  9. the main point as i see it, is if we have major amounts of monopoly/monopsony power

    then we need minimum standards for employee pay

    want to totally get rid of minimum wage, and collective bargaining

    totally get rid of monopolies

  10. The minimum wage is a consequence of fewer members of Unions, Neo-Liberal free Market economics,legislation that nullifies union activity, whilst allowing unlimited price rises solely constrained by market principles.

    The other major factor is that whilst prices have continued to rise, Neo-Liberal governments have transferred public services into private hands and introduced payments which were once free. Meaning that what we recognised as the social wage, cheap or free public services has now to be paid for, i.e. University students used to get grants to pay for fees and accommadation, today those students have to take out loans with long term debts, effectively privatising higher education without anyone realising it.

    Housing was an important factor in stabilising housing costs, that was council houses with cheap not for profit rents, would act as a natural break on housing inflation, but with the drive to in-debt more of the population. Council houses were sold off as a deliberate policy to force people into buying private houses, thereby driving up house inflation, inline with increasing the debt burden on people.

    With all of these additional costs imposed on people as a whole, is anyone surprised that the economy is shrinking and that some form of basic income becomes essential.

    Having been involved with a radical local organisation that decided we should do something practical prior to Christmas; to keep homeless street dwellers warm and somewhere to get a snack and hot drink; we of course met head-on, the plight these individuals were suffering.

    Not surprisingly they told us it wasn't an insufficient increase in the minum wage they needed but all those things Neo-Liberal politicians have taken from the=m over the years. Like cheap housing, like benefits, and all those public services that have over time disappeared or to expensive to receive.

    None of this is rocket science.

  11. I think most of the arguments in this post are fairly reasonable and realistic, and that is quite surprising both because this is a post not entirely the usual "rah rah" style anti-Corbyn, pro-"Remain" post of some year past. I am amazed that also some recent posts here show that our blogger seems to have come around to the notions that while Corbyn is not perfect his leadership is not a catastrophe, and that while "Leave" is an expensive mistake, it won't cause the collapse of the UK economy.

    As to the specific topic, well duh: there is not one labour market for the commodity "labour", but many local markets which are often not that competitive. In practice markets and their supply and demand depend on institutional situations. Plus there is a big difference between the meaning of employment as "hours worked" and "having a job at all"...

    One way I like of looking at "markets" is to draw the "supply" and "demand" schedules not as lines but as ribbons (fairly wide ones usually) and to add that actual market transactions usually happen at some point within the ribbons, the exact point determined outside the market, typically by institutional arrangements.


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