Monopsony in the NZ labour market?

As part of catching up with what has been happening in New Zealand I am reading what I can find from New Zealand economists.  In doing so I wandered onto this piece by Shamubeel Eaqub of Sense Partners.

Firms are finding it hard to recruit, as the pool of qualified job seekers who are not already employed is so small. … (But) Wages haven’t risen in tandem. Wages have been increasing in some sectors like construction, but have been stagnant in others. … One explanation for this may be a lack of competition in a local labour market.

The increase is from a low level and evidence from the US on minimum wages suggest such increases don’t cost jobs, but improve the incomes for the working poor.

So there are two claims embedded in this that I want to think about a bit here: Competition through monopsony and the efficacy of a higher minimum wage in the NZ context.

Is there suggestive signs of monopsony in NZ’s labour market (Tl;dr is YES and NO), does this imply minimum wages could increase employment (Tl;dr is YES if monopsony holds), does this suggest higher minimum wages would increase, or at least not reduce, employment (Tl;dr is probably NO at current levels).  Although we will be going through a bit more than this in what has turned into a long post.  Let’s do this.

Do what.  Ahh what monopsony?

Ok so a monopsony is a situation where we have a single buyer in a market.  We are using the term loosely, so we aren’t thinking just of a monopoly itself – just a situation where there are many sellers and buyers that have price making power.

In the labour market the sellers are wage and salary earning employees, the buyers are firms, and the the price is the wage rate!

If we have a monopsony then the level of employment (hours of work of employees in total, so either fewer workers or workers working fewer hours) will be lower than if things were “competitive” and the wage rate would be lower.  If you want a picture the Wikipedia article on this is very clear, so let us borrow that:

So the idea here is that we have a demand curve for the firm (called MRP here – which is the marginal value of hiring), a supply curve of employees (called S), and an associated marginal cost of employing someone (called MC).  Our monopsony is assumed to be acting in a maximising fashion – no x-inefficiency here (we get to that later) – and so the marginal value of hiring someone is set equal to the marginal cost in equilibrium … or employment (L) is chosen such that MRP=MC.  That firm is a “price maker” so they set the wage that gives this level of employment, which is a wage on the labour supply curve – w in this example.

In the competitive equilibrium the firm and employee choices looks different such that equilibrium is where S=MRP, which has higher employment and a higher wage!

Right, so what do we observe in real life data if there exists such a monopsony?  There are four things we can take from our above diagram:

  1. Wages are low relative to productivity.
  2. Employment is “low” relative to similar countries without the competition issues.
  3. Participation is “low” relative to similar countries without the competition issues.
  4. Firms are willing to hire more staff at the current wage, but are unwilling to increase wages.

Now these are tough issues to tease out, let us go one by one.

Are wages low relative to productivity growth?  There is a suggestion that this is the case, given the falling income share documented by the Productivity Commission (albeit less severely than overseas) and a look at the base wage data by Bill Rosenberg. [Sidenote:  I am coming back to the factor income literature again as well – if there have been cool things written about this in the last four years throw them in the comments 🙂 ]

Now this doesn’t tell us that wages are low relative to productivity by itself – but competition issues may be one of the explanations for why that has occurred.  It is consistent, but would need to be tested against alternative hypotheses like those given by the Productivity Commission.

Are employment and participation low?  No, not in the slightest these are very high in New Zealand.  This is a significant issue for arguments of monopsony in New Zealand – we need some other institutional explanation of this to tie it all together.

Are firms willing to hire more staff at the current wage, but unwilling to increase wages?  Oww yes.  NZIER’s QSBO constantly points to massive shortages of skilled and unskilled labour in New Zealand.  And yet, firms refuse to increase wages.

Why is this a symptom of monopsony?  A monopsony observes/faces an upward sloping supply curve rather than a “flat” one.  So the only way to increase employment is to increase wages.  For a competitive firm, they just hire another worker at the current wage – but a monopsony is rationed and has to pay a higher wage to the new employee AND all the other employees they have.  As a result, the cost of hiring another employee is greater than the wage they pay them – and so even though they would be willing to hire that person in isolation, the fact they need to increase wages to everyone else makes it too expensive.

Note: This is where we need to be a bit careful saying “aha it is the Employment Contracts Act”.  The ECA introduced individual bargaining and as a result the firms could now price discriminate …. which should have then led to lower average wages but higher employment than in the monopsony case.  Firms would be willing to increase wages UNLESS that led to higher wage demands from current employees, making that wage bargaining process itself the limiting factor.  Things get complicated when we try to include specific institutions 😉

So at face value we have two yes’s and two no’s when thinking about monopsony in the labour market overall.  Notice I said nothing about concentration measures, I did this because I think they are a bit over-rated relative to looking at the consequences we would expect in the labour market if the concentration truly was excessive 😉

Now this is an issue I’ve been interested in for a while, but the only paper I had found testing for monopolistic competition was this one here by Morrison, Papps, and Poot – they found evidence for it.  If anyone has some more research please share it in comments.

Say there is monopsony/monopolistic competition. How does this relate to the minimum wage.

This was one of the first issues we discussed back in 2007.

Ultimately, if the issue is low wage firms acting in this way, then a minimum wage replaces the upward sloping supply curve with a flat one for the firm … thereby increasing wages and employment.

So yes, introducing a minimum wage where there wasn’t one when the labour market has this design can increase employment while lifting wages.

For this discussion a broad issue is that the minimum wage is only for the bottom of the wage distribution – if there are monopsony issues they are likely to be occurring for higher wage earners as well.  However, assume for now this policy prescription is due a particular focus on the lowest wage earners.

So increase the minimum wage and increase employment?

Logical arguments don’t always remain valid when we pop a word in front of each of the nouns, this one doesn’t hold.

The introduction of the minimum wage increases employment if it is binding.  But once that wage rises above the “competitive level” in our model, increasing the minimum wage still involves our firm moving up its demand curve, thereby reducing employment.

There are trade-offs here, an example of thinking about this can be found by looking at our old discussion on the living wage.

As mentioned in that conversation, NZ is nothing like the US.  NZ still has the highest minimum to average wage ratio in the high income OECD nations – and the incentive for firms to reduce output or substitute towards capital instead of labour increases the closer minimum wages get to the average wage.  As a result, let us be a bit careful just taking overseas estimates as an estimate of what will happen here 😉

Another factor to keep in mind if you will not accept the current minimum wage is likely to be near or above the competitive level – in this model the higher minimum wage can only boost employment by increasing labour market participation.  In a nation with exceptionally high levels of labour market participation like New Zealand the scope for this appears very limited.

And if wages are being pushed above their competitive level it isn’t just a matter of lower employment that becomes concerning.  We now need to consider dynamic effects, firms will adjust investment patterns – either to substitute away from labour (self service checkouts) or to generally reduce the scale of their operations and output.  Non-tradeable prices will rise, reducing competitiveness on international markets and thereby reducing New Zealander’s ability to bring in imported consumer goods.  It is no longer a straight transfer from capital owner to minimum wage employee – instead we face a series of broader economic consequences.

We may view these are a fair cost for something we view as equitable, that is cool, but I think this indicates that the argument gets a little more complex than a simple minimum wage hammer allows for … after all I haven’t even mentioned that it is highly skilled labour that firms primarily complain about not being able to get hold of at the current wage rate, suggesting that the minimum wage and its focus on less skilled labour tasks may not be related to the core competition issue observed in the labour market.

But insert X-inefficiency argument

Note:  This is a side issue I have decided to cover as I thought it was important to give the above discussion more context – it is not a direcct comment on any of the content of the stuff article.

Yes, firms aren’t single profit maximising entities.  They are made up by complex decision makers acting in their own interest while boundedly rational.

A monopsony behaves different than competition as a result of this as well, which is not part of the above model.  Employers within the firm want to protect their status, protect the value of current employment, or build up a group with a certain set of characteristics – and this can all be completely unrelated to a profit maximising target.

But if we want to argue “competition” and “minimum wages” we have to work out what type of inefficiency we are discussing to describe it.

If people in firms, and unions, are interested in increasing returns to the employed while excluding the “outside” group from the labour market then wages rise and employment falls.  If this is broken and labour market access and flexibility are improved for workers then there is downward pressure on wages and increases in employment – a set of responses that is consistent with NZ experience.  I am not arguing this is the case, but just pointing out that as soon as we cry “x-inefficiency” we get arguments that both justify as well as disagree with policy changes that have happened in NZ.

There are winners and losers here, but that is the thing policy changes do have winners and losers.  When we look at x-inefficiency the winners and losers change from a faceless firm vs wage and salary earners we relate to, to a series of different wage and salary earners as well as capital owners who we can all relate to in some way.

I am not saying we can’t make important policy relevant arguments – I am just saying we have to actually make them, rather than just mentioning X-inefficiency exists.  As its existence may actually undermine our policy recommendation rather than support it 😉