A few years ago Gulnara and I made a video on unemployment. Although this was a particularly unpopular video, it was actually one of our favourites – and we keep thinking about ways we want to expand the story of our friend JM.

In this video we give examples of how JM, a lawn mower man, could end up unemployed. A key example we gave was the creation of autonomous lawnmowers. We were then shocked when we walked into a store to see the following:

So what does the existence of automated lawnmowers tell us about JM, and how does it help us think about labour markets?

All the ways to mow a lawn

As you can see from this Frankenstein image from Dall-E, there are many ways to mow a lawn.

• Use scissors.
• Use a hand mower.
• Use an electric push mower.
• Use a ride on mower.

As we move down this list we are using a technology that can cut an amount of grass more quickly, and with less human effort.

These tools, or capital equipment, allows a person to cut more grass using one hour of their time. As a result, an individual can complete a task more quickly – and them (or their employer) will invest in these tools if the cost of capital items is sufficiently low that the saved labour cost is attractive enough.

However, more complex tools also require greater knowledge. It’s pretty easy to use a pair of scissors – but a ride on lawnmower requires maintence, knowledge of how to drive, and knowing when and where to change mowing settings. This implies that individuals have skills that allow them to do tasks using specific capital items/productive processes.

But now a new technology has appeared.

The automated lawnmower and our lawnmower man

The lawnmower man from our video – JM – had invested in a good lawnmower (physical capital), relationships with customers (intangible capital), and the skills to utilise these (human capital).

The relatively cheap consumer lawnmower strands all of this capital – JM’s customers can now replace JM with a robot, and within a year they have saved money.

JM could cut how much he charges, or only serve the small part of the market that doesn’t trust robot lawnmowers. But either way, the return he receives on his capital is now much lower.

If JM was renting the machine, and if people simply reached out to him on a platform without relationships, then his income would have solely been a result of his skill at performing tasks. As the new technology can perform the task at a lower cost, his return on this skill will now be lower.

And if its low enough he’ll be forced to drop out of lawnmowing and find something else to do.

Next steps for JM

The art of lawnmowing may have lost some of its allure, but that does not mean that JM does not maintain any skills from his background with the rotary blade.

He dealt with customers, he managed his own accounts, he learned about repairing machinery, and he understood how to deal with difficult situations.

The routine task of walking around with a lawnmower may have been replaced, but the non-routine task of managing relationships with customers is something JM will need to do in many other jobs.

More importantly, JM has a number of general skills that can be shared across jobs – skills that he will still earn income for when finding his next job. Specific skills associated with lawnmowing have lost value – but how much of his earnings was really a function of being a good lawnmower, rather than being good at running a business and managing relationships?

This question about the skill content of tasks, and the ability for people to substitute when there is a shock to the return to skills, is a key one in labour economics.

In fact this is a key motivating factor for much of the wage scarring work that was mentioned last week. If people are facing shocks that lead to a sharp decline on the return to their skills, we would expect to see long and persistent earnings scars for these individuals.

JMs journey will depend on how well he can substitute to a new job in a world of technological change. In fact, it will depend on how well any of us can adjust – even economists.

Previously we’ve talked about the cost of job loss in terms of revealed consumption responses – i.e. how do individuals cut their spending following job loss. This is a useful concept, and there is going to be more to say on this in the next year.

But a more basic point people may ask with respect to the cost of job loss – how much lower is someone’s lifetime income if they end up getting shoved out of their job!

Let’s chat about that while investigating some initial work my colleagues and I have undertaken at e61. For those who know things already, or don’t want to read, here is the picture you are after:

What is wage scarring?

Imagine you are sitting there doing your thing, working for your generic employer, doing your generic job, thinking about the great things you’ll do on the weekend.

Suddenly, the government says that everyone who has a tax file number that ends in three has to leave their job and cannot be reemployed at the same employer.

That would sort of suck – but it would be a purely exogenous job loss. After that job loss you would go around applying for jobs, trying to understand what might suit your skills, figuring out if you should move country or study etc etc.

Eventually you would find a job, and over time you would progress in that job and earn an income.

Wage scarring reflects the difference in wage earnings between this job, and what you would have earned if you had not lost that initial job (the counterfactual).

We can work out this counterfactual you by considering what happened to individuals who didn’t have a tax file number that ended in 3, but otherwise look very similar. If you would have earned income in a similar way to them in the absense of job loss then the difference between their earnings and your earnings is as estimate of the wage scar you experienced.

Who cares?

It would be easy to say “this is an important measure of the harm from job loss”, but this is actually a question that requires a bit more.

By just framing this as a measure of labour market costs from job loss, it is easy to just view this as a realisation of labour market risk.

If this is the case, then these job losses are just a product of the world changing and a product of the risk we have in life – in that case any arguments about this relate back to how we feel about self vs social insurance for labour market risk.

However, lets think about some of the reasons why income may have declined for the person:

1. Time out of work see’s the workers skills become less valuable (loss in human capital).
2. Technological change has reduced the value of individuals skills (loss in human capital).
3. The firm was a high productivity/high pay firm (firm value/rent).
4. The match between the worker and the firm was better than a new match (match value).
5. The worker was very knowledgeable about using systems at that firm to their best use (match specific capital).

And what about the firm?

1. The value of the worker had declined, but not the tasks involved in the job (reduced match value).
2. The value of the tasks declined (reduced job value).
3. External factors (i.e. credit constraints) forced the firm to end a productive match.

Each of these combinations of reasons why the firm ended the job and reasons why the worker ended up with lower income has different interpretations. Some are just transfers from the worker to other people, while others show loss of surplus that imply this is a net loss in income over everyone.

If we want to fully think through the consequences of shocks that lead to job loss we have a lot of other things to think about. However, understanding the income loss associated with an exogenous job loss helps us start to tease out this problem – and also understand the cost for people who face job loss.

Why do you keep saying exogenous

Fair.

Job matches can end for a whole bunch of reasons. There can be self-selection (i.e. a job-to-job transition or “voluntary” unemployment where the worker quits) or there can be firm selection (being fired).

Self-selection isn’t really our focus, as it is likely people are leaving jobs to get a better job!

Firm-selection also has an issue – as the firm is likely to remove their “least productive” or “worst matched” workers. As a result, they select a type of worker that they were not going to give a pay rise – and so comparing them to other workers will overstate the income loss from this event.

We are trying to isolate the effect due to job loss – not due to selection. As a result, we want to make a case why the job losses we’re looking at do not involve much self-selection or firm selection. Now it is unlikely that we can find a perfect experiment here, but we just need to be clear about this!

What does prior evidence say?

International studies

I’ve already written a lot of words, so I’m going to share a table from Bertheau et al. (2023).

So the five year scars estimated tend to be between 6% and 36%.

What about New Zealand – Hyslop and Townsend (2017) found scars of 13-22%.

The Australian case

There have been a few recent studies in Australia, lets list them out:

1. Lancaster (2021): Using survey data there was no additional wage scar found after 5 years – involved looking at all unemployment.
2. Ballantyne and Coates (2022): Using survey data a scar of around 10% was found after 5 years – again looking at all unemployment.
3. Andrews et al. (2023): A recent e61 piece using administrative data found a 29% scar – focuses on those who are made redundant in ATO data.

Well, what do you all do?

Selection and triggering events

So looking at our piece – specifically the technical appendix – we are looking at a very specific event, influencing a very specific set of firms and workers.

• The Global Financial Crisis (GFC) year.
• Firms who have let go over 30% of their employees for a persistent period of time (mass layoff).
• Workers that leave a mass layoff firm during the GFC.
• Workers who are in their sixth year of work at the same firm (long tenure).

The comparison is then between long-tenure workers who left a mass layoff firm vs long-tenure workers who did not experience this.

What does this have to do with selection? Well a mass layoff helps to mitigate firm selection – as they have many of their workers at the same time.

However, who is to say that these aren’t still the least productive? To help with that we look at long-tenure workers, who have formed a relationship with the firm and where the worker and the firm really know each other.

Results

For most of the results I’d suggest reading the note – it is only 2 pages long

But lets list some highlights here.

What is our five-year scar? 16% of earnings – so the individuals who lost their job in a mass-layoff have earnings 16% lower than expected.

How much is this just about people having trouble getting and maintaining work, as opposed to employed individuals earning less?

Turns out a lot. Those who are re-employed after 1 year (who stay re-employed) have no scar after 5 years. Those re-employed within 5 years have 5% scarring.

So wait a second, if someone in a high status job gets paid more for the same effort and same contribution then why are we talking about marginal revenue product? Shouldn’t they already be rewarded by status? Is this a product of power? Let’s have a think

Lets write the three elements here out:

• Work that is separated by “social standing”, and remunerated differently, may be similar in form.
• A labour market represented by the standard neoclassical model – which represents a tendency in markets where there is effective competition – wage is equal to the marginal revenue product.
• Wages do not represent the value of the individual within society, and may even differ from their value in employment.

Betsey uses these items as a way of making explicit that descriptive assumptions of a model should NOT be confused with broader normative assumptions. And that it is the role of someone using economics to, as far as possible, clearly separate these. Very true.

However, I think it also illustrates a general confusion about economics. Economists build models that explain tendencies, and the reason the tendency occurs – then when we understand the conditions within which these tendencies occur we can use these models as a framework to use real data, and in turn investigate whether these tendencies occur in the area of interest or not.

There are MANY other determinants of wage than marginal revenue product in many circumstances. But the neoclassical model has value in so far as it describes a tendency for the level of wages to move with marginal revenue product – and how it can be used to evaluate where the incidence of this falls given a variety of market structures.

An economist is never saying that a single incentive causes everything, or that a price or wage is the sole determinant of an action. It is evaluating the tendency for change in outcomes given an isolated change in an incentive – be it a price, wage, or some other attribute we are able to measure. Given that we can then use this framework to measure and understand our measurement.

That is pretty cool.

Wages are termed sticky when they don’t adjust to the optimal level driven by the changes in labour market conditions. The interaction between sticky wages and economic shocks helps to generate the business cycle, and also causes a lot of the most costly elements of an economic downturn – unemployment and losses in skills. 

As I have discussed in a previous post, prices as well as wages can be sticky. However, the focus here is on the inability for wages to change from a predetermined path – specifically the downward rigidity of money wages.

A strong reason why wages can be very sticky is unionisation.  Unions and employers both use size to generate a bargaining position to negotiate wages.  As part of this strategic negotiation, unions (at least in the Anglo-Saxon sense) tend to promote relatively sticky wages – and demand persistent increases in wages even when the economic cycle turns south.

But what does this have to do with wage inequality?

Note:  There are multiple models of unionisation and social assistance – Matty pointed out that the books “Varieties of Capitalism” and Chapter 13 of the Oxford handbook of the welfare state are a useful read for thinking about this.  The response of unions in Germany during the GFC and COVID show that the relationship between unions and stickiness is complex – and the assumption they are related is based on the experience of Anglo-American economies in the 1960-1980s.

So what does this have to do with wage inequality?

Biasi and Sarson (2020) provides an interesting link between flexible wages and the wage gender gap.

The authors find that the wage gap between women and men offered by flexible payment agreements is higher than under the collective bargaining agreement. 

Collective bargaining agreement introduces wage stickiness to the economy, as the union’s agreement usually includes a wage rise by a certain amount each year. 

However, these agreements don’t discriminate against employees based on their gender. And since these agreements are made prior to any downturn, wages continue to rise even though the revenue generated by each worker falls.  Such stickiness can then force employers hands, making them lay workers off rather than cutting wages.  Weakening union power to allow more flexible wages appears to help solve this issue. 

Note: Again this is a simplistic form of unionisation – by supporting job transition, or creating a cost for layoffs, unions might also prevent large swings in unemployment.  Ultimately what matters is the specific form of unionisation that is used – and for clarity we are assuming a form that ONLY makes wages more rigid.

However, even if there are issues of wage rigidity generating excess swings in unemployment the same unionization can also help narrow the gap in pay between similar workers due to collective agreements.  Collective agreements are often transparent and are based on objective criteria – specifically non-discriminatory criteria.  As a result, if a man and a woman are equally likely to get selected into a job (another area of potential discrimination) unionisation helps to ensure they will get paid the same.

In history this was not always the case – with unions and other institutions specifically including wage discrimination as a target on the basis of the “nuclear family-male breadwinner” view of the world. Modern unions are not expected to do this. However, the selection into a job issue remains important – as it is one of the main reasons why the wage gap exists, rather than due to differential payments for the same job.

The evidence seems to support this view of the wage gap and unionisation. In this study the authors note that the union wage gap (or mark-up) in the UK in the 1980s was approximately 10%. It was highest for women, part-timers, those who lived in the North, in high unemployment areas and worked in small plants.

As a result, although we normally view wage stickiness from unions as negative – as during a recession this can lead to more people out of work – such agreements can also help to achieve other social ends, namely closing the wage gap (reducing discrimination).

In the first few days back, I have heard a lot of people from around the building talking about how they prefer different work arrangements – and I’ve heard a lot of people say that they felt more work was being done away from the office.  And yet, teams appear to be making the choice to move back to the office.  Why is this the case?

Although it may be the case that the teams stated and real preferences differ, I suspect there is something else at play – strategic complementarity.  Once we understand this concept it can become clear why we can end up in a worse equilibrium with regards to our work arrangements even when given flexi-choice, and why explicitly promoting working from home could be a “win-win”.

My choice depends on your choice

To understand how strategic complementarity works it is useful to look at an individual’s choice regarding where to work in two scenarios: 

1. When everyone else is working from home,
2. When everyone else is working from office.

In scenario one, everyone else is working from home.  Because of this all meetings will be online (via Teams or Zoom), there will be no workplace gossip to miss out on, and no-one will look strangely at you if you fold clothes while you are in a meeting.  In this case there is a strong incentive to work from home.

In the second scenario, where everyone is working from the office, it becomes more difficult to work from home.  You get shut out of meetings, people catch up on each other’s lives without you joining in, and a decision to fold your washing during a meeting would go down poorly with your boss.  As a result, the incentive to work from home is much lower – and with the benefit of group chats and getting heard at meetings at work you have a strong incentive to also go to work.

Because you have a greater incentive to work from home when others do, and a greater incentive to work from the office when others do, these actions are strategic complements.  If someone decides to work from the office, it increases pressure for other people to work from the office – and if someone switches to work from home it increases the pressure to work from home.

This leads to multiple equilibria.  Namely, when the number of people choosing to work from home increases, the effectiveness of that type of arrangement works well and an additional person will have an incentive to work from home. Similarly, when the majority of people choose to work from the office increases, it functions well as well and an additional person has an incentive to work from the office. 

In a simplistic example, people in both cases choose to go with what the majority is doing, and we end up with two equilibria points – all work at home or all work in the office.

Is the equilibrium we choose the best (Pareto Optimal)?

The answer is not necessarily.  The equilibrium selected isn’t based on the underlying preference regarding working at home or the office – but instead is history dependent or based on what has happened in the past and what people expect others will do.

In our example above it sounded like the individual would like to work from home all things considered – but with a push to get back to normal and get in the office they know that their workmates will be in the office, as a result they also go to the office. As they are making their choice to go into the office based on the expectation that others will go to the office – and not because they actually prefer working in an office – this equilibrium is Pareto Inferior! 

So what is the takeaway here?  Just because historically, everyone chooses to be in the office, it doesn’t mean that we shouldn’t be open to better ways of working. If it is true that people are just as productive, and are happier, when working from home then that is something worth encouraging – but due to strategic complementarities it is not something that will organically occur if we simply state that flexi-work is allowed.

So how can we think about the labour market in a world where work switches towards the gig economy?

If we compared an employment contract offered by McDonalds to the casual contract offered to the Uber worker, which option would one choose? If both are offered then this depends on preferences. 

The benefits of being a gig worker is an employee’s freedom, with no manager assessing the performance, no timatables attached to the daily work routine, and no location specific restrictions such as transportation costs are applied. 

The drawbacks of these types of casual contracts are the lack of job security, no employment benefits from your employer (bonuses), bank loans conditioned to the employment contract or any other types of laybys , where the employment contract serves as a collateral, overtime payments on holidays, or sick leaves covered by your employer. 

However, there is a broader point – how does the gig economy influence what jobs are on offer.  Does the existence of Uber mean that people are able to move into new types of work, or do they replace other forms of work that would have been available – does it expand people’s opportunities or restrict them?

Why do we care about a surging importance of the gig economy?

As mentioned above, a rising gig economy leads to different types of jobs being on offer.  These may be jobs people want, that may give them greater opportunities. However, they may also replace other job offers leaving workers more vulnerable.

From a policy lens there are two reasons why we might want to consider a given type of job arrangement as being of interest:

1. Due to technological change the arrangement may become more important in the labour market going forward, indicating it is important to understand it.
2. Differential treatment of a given arrangement may give employers or employees the incentive to “reclassify” the work into the new arrangement – which may undermine labour market regulations that protect workers.

Understanding how gig work functions along those two margins allows us to think about the future of the labour market, and also some risks for labour market protections we have in New Zealand.

What are some examples?

Keeping things broad, we can look at specific jobs and just imagine how they may be reclassified.

Examples : 

1. Someone who works as a taxi driver, with an employment contract, gets reclassified to an uber driver without one. 
2. Someone who works in a clothing store as an employee instead joins a “temporary job app” where they get called into work in the store when required

For some this has some attractive features. These types of contracts offer: flexible workforce, more appealing work-life balance, as it does not involve a traditional office hours from 9 to 5. 

However, what about people who want the security of an employment contract when they are in a role.  They now face competition from someone who is using this app. As a result, there are fewer jobs available in terms of traditional hiring, and people who we are trying to protect with labour market regulations have lost those opportunities.

Superannuation and social security makes this more fraught.  

In New Zealand such schemes may allow avoidance from Kiwisaver scheme for employers (eg deviation of employers to pay the 3% opt in fee for employee). 

In the US and many European countries employers might prefer hiring casual contractors on the implicit minimum wage instead of offering an employment contract with minimum wage, in order to avoid coverage of  health insurance of the employees – since the minimum wage floor is binding the entire incidence of coverage from employer funded schemes is on the employer!

Summing up

Gig work, and the opportunities it gives people who enjoy that work, is great.  There are also benefits to employers and consumers from that flexibility (which I have put to the side here).

But, part of the reason why the technological change may be successful is if it allows people to undermine the current labour market protections we have in place for vulnerable individuals – and it is worth thinking carefully about how we can ensure those protections stay in place, and take into account that these innovations may reduce opportunity for some potential workers.

Looking across this blog I’ve seen monopsony discussed in terms of the labour market and in terms of migration and monetary policy.  However, I want to focus on concentration indices (as a proxy for monopsony) and wages.

My friend Chris Ball discussed this at NZAE this year and it has shown up on VoxEU and the OECD recently.  Specifically, I want to consider this point from Chris’s conclusion:

Income growth is generally higher for those in more concentrated industries after adjusting for differences in underlying characteristics. As outlined in Chapter 4 this result is subject to a number of caveats, but even so this is a surprising result because the first principles analysis of monopsony would predict income growth should be lower for those in concentrated markets.

So why could this be?  My guess is that concentrated labour markets may also have market power in product markets therefore:

1. Concentrated markets may have higher productivity growth, allowing them to pay higher wages.
2. Concentrated markets may be subject to greater X-inefficiency due to the incentive for owners to deal with principle-agent problems through contracts, as a result managerial staff may be able to extract greater surplus from the firm – which constitutes labour income.

I am looking forward to more interesting New Zealand work on this issue, as it is something that could be especially important for a small economy far away from the rest of the world like NZ.

Unions are an interesting topic, but are also inseparable from a discussion about the relative welfare state and competition policy embedded in a nation.  Nordic and German trade unions are quite different from the trade unions of the US, UK, and Australiasia – and any evaluation of an institution in this way requires a model that allows us to represent the institution relative to other institutions in the economy, the way individuals behaviour relates to that, and how the outcomes for individuals will vary.

So does anyone want to do some of that in the comments below?  I will hopefully be writing up some things on these issues over time – but as a starting point for discussion I will put up this oversimplification.  Unions help to correct issues of insufficient bargaining power for labour, but like any monopoly their existence leads to deadweight losses which hurt those outside of the unionised industry, and are unfair to capital owners in competitive markets.  Evaluating whether more unionisation is good relies on comparing the costs and benefits given in this oversimplification.

Off we go …

An option that recently popped-up in my mind was about having a four day work week with the remuneration staying unchanged. This idea has already been implemented by a kiwi company Perpetual Guardian which is trailing to raise their productivity.

Let’s consider why the four day work week could be beneficial for both employees and employers.

Employee benefit

An extra day off normally improves our work-life balance – or in other words it allows us to spend more time on leisure (potentially also reducing work-related stress). For some people the cost of leisure is very high. Particularly, this cost is high for sole parents who have scarcity of time and support to spend on their children compared to the couples. Sole parents are also more disadvantaged compared to singles, by having extra responsibilities on their dependents.

What about the transportation burden? For some people, commuting is a big challenge, especially for those who live far away from the workplace. An extra day off would cut the transportation costs and would allow to alternate commuting time with additional leisure time, and they  can handle payment to employees and more using a paystub software online.  Daily long hours on transportation are an external cost placed on the employment process which has a dead-weight loss, which can be reduced by needing to travel less often.

We probably all agree that having an extra day off would improve our work-life balance regardless of our family composition or the length of commuting.

So what happens if “the four day work per week” policy is widely implemented?  Is it a fixed day, should it be up to the employee to choose, or should there be some type of random rotation introduced?

My view is that the weekdays that employees are off should be rotated among workers. If not, then a Friday becomes another Saturday. In this case, everybody has a day off, and problems with “dentist visits” or “children’s school visits” remain unsolved. Adding another Saturday/Sunday to an employee’s life is great, but the marginal improvement is much less than having the day off with rotation.

Employer benefit

At first glance, the approach of paying same wage for 32 hours a week instead of 40, seems expensive. But have we already considered the productivity increase of employees?

An earlier post on  TVHE has already shown that the productivity drops as the number of hours of work rises. A Scandinavian research also demonstrated how the six-hour work day increases productivity here.

“A year’s worth of data from the project, which compares staff at Svartedalens with a control group at a similar facility, showed that 68 nurses who worked six hour days took half as much sick time as those in the control group. And they were 2.8 times less likely to take any time off in a two-week period”.

As a result, higher productivity would at least reduce the cost – if not completely cancel it out.

Although this does raise the question “if firms can get the same output from you in 32 hours instead of 40, and thereby can reduce their costs of operating even keeping wage payments the same (due to other variable costs), then why aren’t they?”.  So do you think there are reasons why firms may be failing to do this, even if the cost or low or it is even in their own interest?

Conclusion

Often time costs us more than million dollars as the happiness cannot be quantified or bought by money. Any company caring to keep their trained specialists around might want to be ready to cover this cost.

A successful outcome of the Perpetual Guardian’s trial on four day work could encourage other companies in NZ to think about how to widely apply this policy among their employees.

I wonder what your thoughts on this topic are. Do you think shifting from five to four days work might impact the NZ economy significantly?

]]> 12910 http://www.tvhe.co.nz/2018/07/31/monopsony-in-the-nz-labour-market/ Mon, 30 Jul 2018 20:00:15 +0000 http://www.tvhe.co.nz/?p=12881 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:

https://upload.wikimedia.org/wikipedia/commons/c/cb/Monopsony-static-partial-equilibrium.svg

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