Is There Monopsony Power in U.S. Labor Markets? The 'new monopsony research "does not make a convincing case for government intervention.

• Author: Soares, Pedro Braga

The 2022 Economic Report of the President devotes a whole chapter to the role of monopsony, monopoly, and discrimination as barriers to economic equality. That monopsony power --market power held by buyers--is given equal billing to the threat of anticompetitive conduct in product markets or prejudice in hiring is striking. Yet, monopsony is alleged to be rampant in the labor market as employers hold wages below competitive levels.

Once regarded as a mere intellectual curiosity, interest in monopsony as it applies to labor has exploded among economists, policymakers, and politicians in recent years. For a sense of this, consider that just two published economics journal articles used the term in the 1980s; in the 2010s, 64 did.

Partly spurred by this recent literature, the Biden administration contends that monopsony power is "ubiquitous" in U.S. labor markets and requires corrective policy responses. The 2022 report advocates countering employer power with stronger support of labor unions, higher minimum wages, the application of antitrust laws to labor markets, and bans on noncompete agreements.

Is monopsony power really an appropriate model of the American job market? On inspection, many of the studies that are cited as evidence of this power are not convincing, and newer research finds relatively small markdowns on wages. The policies advocated to correct for monopsony power often produce outcomes inconsistent with the idea that these labor markets are monopsonies. And there are real risks that proposed interventions will eliminate job or remuneration agreements that workers value.

THEORETICAL OVERVIEW

Monopsonies are the flipside of monopolies. In monopolies, there is only one seller and many buyers; in monopsonies, one buyer and many sellers. A situation with one or few buyers and many sellers may be a good approximation of some historic labor markets, the textbook case being a factory town where the factory employs most of the resident workers.

Most labor markets have more than one firm hiring workers, but many economists worry about labor markets being highly concentrated. Concentration can theoretically be a source of market power in labor markets, especially when coupled with barriers to employer entry. But concentration and market power are not synonymous. Market power in labor markets means that employers can maximize profit while paying wages below the marginal revenue product generated by workers--a wage markdown. Concentration merely means that one or a few firms are responsible for a substantial fraction of employment. Other factors, such as potential competition, can curb employers' market power even in a concentrated market.

Another possible indicator of monopsony power is the elasticity of labor supply that an individual firm faces. This elasticity measures the sensitivity of labor to wage changes. An elastic supply means any decrease in wages will decrease the quantity of labor supplied substantially. At the firm level, employers without labor market power face a highly elastic labor supply: if they decrease wages by a small bit, employees tend to go elsewhere. In contrast, a monopsonist faces relatively inelastic labor supply: if it marks down wages, workers respond less to the decrease.

What are the implications of monopsony market power for wages and employment? In a competitive labor market, employers and workers represent a small fraction of labor market transactions. Therefore, it is reasonable to model the competing businesses as "wage takers," meaning that market forces, and not employers, dictate the wage rate.

In a monopsony model, employers have the power to set overall hourly compensation rates below competitive market rates. This results in their employing fewer people than in a competitive labor market because some prospective employees decline the offered wage, reducing total output. The lower wages paid to actual employees increase average profit per unit of output and overall firm profits. Raising the wage to attract the prospective employees is assumed to require the employer to raise wages for all workers, reducing total firm profits. Thus, monopsony is a source of inefficiency because, by reducing labor that would have been hired at the competitive rate, this form of market power reduces output and prevents transactions that otherwise would have occurred.

Many people think government can reduce this inefficiency. If a policymaker could set a minimum wage, for example, between the monopsonistic and the competitive wage rates, this would deliver a "double dividend" of more jobs and higher pay. Similar logic dictates that labor unions could offset monopsony power or that antitrust enforcement that reduces monopsony power could reap the double dividend.

Monopsonistic competition / How realistic is this as a model of the labor market? There are important caveats.

First, pure monopsony does not exist; all job markets lie between fully competitive and monopsonistic, with a firm's degree of power determined by both within-market forms of conduct and by government policies that affect entry and thus competition. Businesses in highly concentrated sectors could theoretically collude to suppress wages, but they could also engage in competition. Under some conditions, only two firms might yield a competitive equilibrium. Governments can also be...