Monopsony in American Labor Markets (original) (raw)

What is Labor Monopsony?

The term "monopsony," first used in print by Joan Robinson (1969, p. 215), means a single buyer in a market. Like a monopolist (a single seller), a monopsonist has power over price through control of quantity. In particular, a monopolist can push the market price of a good down by reducing the quantity it purchases. The tradeoff between price paid and quantity purchased is the supply curve that the monopsonist confronts. A competitive buyer, by contrast, confronts no such tradeoff -- it must accept a price determined by the market. A monopsonized market will therefore be characterized by a smaller quantity traded and a lower price than a competitive market with the same demand and other costs of production.

Monopsony power, like monopoly power, results in economic inefficiency. This is because the monopsonist avoids purchasing the last few units of a good whose value to the monopsonist is greater than their marginal cost, in order to hold down the price paid for prior units. In principle, inefficiency from monopsony can be mitigated by a well- placed legal price floor, which removes the monopsonist's power over price and eliminates its incentive to restrict the quantity it purchases. A modest price floor forces the monopsonist to take price as given and increase its purchases toward the level of competitive buyers. However, if the price floor is too high, the monopsonist will reduce its purchases -- just as competitive buyers would do in response to a price floor -- and inefficiency recurs.

In labor markets, "buyers" are employers, "sellers" are individual workers, the "good" is time and effort, and the "price" is the going wage or salary level. An employer who enjoys monopsony power holds down the wage by limiting the number of workers it hires. At the resulting inefficient level of employment, the value of the last worker's contribution to output is greater than the wage she or he receives. This gap was termed the "rate of exploitation" by Pigou (1924, p. 754). It can be shown mathematically that a monopsonist employer will choose a rate of exploitation (expressed as a percent of the wage actually paid) equal to the reciprocal of the elasticity of labor supply (the percent of the workforce lost if wages are cut by one percent). Competitive employers face an infinite elasticity of labor supply -- if they cut wages they lose their entire workforce, at least in the long run -- and consequently are unable to exploit their workers. Competition thus forces the rate of exploitation to zero. Monopsonist employers by definition face a finite labor supply elasticity. For example, if a monopsonist faces a supply elasticity of five, then five percent of the workforce would be lost if wages were cut one percent, and it can be shown that the monopsonist will choose a rate of exploitation equal to one-fifth or twenty percent. Inefficiency and "exploitation" from labor monopsony can be mitigated by a well-placed minimum wage enforced by the government or perhaps by a labor union. Thus the monopsony model can provide justification for minimum wage laws and unionism because such measures raise pay, increase employment, and improve economic efficiency simultaneously!

Elaborations of the Monopsony Model

Cases of isolated labor markets with only one employer are surely rare, so the model must be elaborated to fit the real world. One elaboration is oligopsony. In oligopsony models, employers hold power over wages if they are few in number. This power might derive from collusion if employers cooperate in setting wages. Or it might derive from inflexibility of their respective workforces. The latter situation, called the Cournot model, implies that an individual employer that cuts wages cannot lose all its employees to its rivals, because those rivals cannot absorb additional employees quickly. Consequently, each individual employer enjoys some power over wages. Both collusion and the Cournot model imply that the greater the concentration of employment in a small number of employers, the lower the wage and the higher the rate of exploitation, holding determinants of labor demand and labor supply constant.

Another elaboration is employer differentiation. If employers differ by location or by working conditions, workers may not treat them as "perfect substitutes." An employer that cuts wages might lose some workers but not all. Thus an individual employer enjoys power over wages to the extent that its rivals are far away or offer very different jobs. Recent elaborations of the differentiation concept focus on the process by which workers are hired. Models of moving costs emphasize that workers, once hired, may require a substantial wage increase to switch firms. This gives an employer power over wages for its existing workers, but not for new hires. Models of job search emphasize that workers need time to find better jobs. Thus an employer need not match the wages of other employers. However, to maintain a large workforce, an employer must pay better-than-average wages to reduce quits. Note that both moving costs models and job search models imply that workers are more mobile in the long run than in the short run. As Hicks (1932, p. 83) noted, monopsony power depends inversely on "the ease with which [workers] can move, and on the extent to which they and their employers consider the future, or look only to the moment."

Athletes

A striking example of monopsony in an American labor market is professional baseball. Until 1976, the "reserve clause" in player contracts bound each player to a single team, an extreme form of collusion. As a result, teams did not compete for players. Estimates by Scully (1974) and others indicate that rate of monopsonistic exploitation was very high during this era -- players were paid less than half of the value of their contribution to output, and possibly as little as one-seventh. After the reserve clause was eliminated in 1976, players with at least six years' experience became free to negotiate with other teams. Salaries subsequently soared. By 1989, the rate of exploitation was estimated to have fallen close to zero (Zimbalist, 1992).

The early history of baseball, when rival leagues occasionally appeared, yields similar estimates of monopsony exploitation. Rival leagues undercut the reserve clause, which could only be enforced among teams in the same league. Thus the appearances of the American Association in 1882, the American League in 1901, and the Federal League in 1913 each prompted rapid increases in player salaries. But when the rival league was bought out or merged into the dominant league, salaries always dropped sharply -- usually by about a half (Kahn, 2000). This history suggests that, in the absence of rival leagues, early professional baseball players were paid no more than half of the value of their contribution to output.

While no serious rivals to Major League Baseball have appeared since the early twentieth century, rival leagues have frequently appeared in other professional sports. For example, the American Basketball Association challenged the National Basketball Association from 1967 to 1976, the World Hockey Association challenged the National Hockey League from 1971 to 1979, and the United States Football League challenged the National Football League from 1982 to 1985. The appearance of each of these rivals seems to have caused player salaries to increase substantially in their respective sports (Kahn, 2000).

An even more striking example of monopsony is the market for college athletes. These players are clearly employees in all but name, but the National Collegiate Athletic Association strictly limits the amounts that athletes at member colleges and universities can receive. The value of the output of top college football players has been estimated at about $500,000 (Brown, 1993), many times more than such athletes are "paid."

Teachers and Nurses

For the last few decades, researchers have investigated whether the markets for American school teachers and nurses are characterized by monopsony. Both professions may face a limited number of potential employers in any given geographical region. For teachers, employers are school districts, which are separated by political boundaries. For nurses, the dominant employers are hospitals, which are dispersed geographically except in large metropolitan areas. Moreover, teachers and nurses are (still) predominantly married women, who may find it difficult to move to a new geographic area if their husbands are employed. Researchers have considered both oligopsony and differentiation.

Early investigations measured the relationship between employer concentration and wages. A negative relationship, holding everything else constant, would suggest oligopsony. Several early studies -- for example, Luizer and Thornton (1986) for teachers and Link and Landon (1976) for nurses -- did in fact find negative relationships. Yet it is unclear whether everything else was held constant in these studies. Highly concentrated markets with small numbers of employers for teachers or nurses tend to be rural areas and small cities. Less concentrated markets with many alternative employers tend to be large cities. But pay for most other occupations -- even less specialized ones with many potential employers -- is lower in rural areas and small cities, so it is not clear that monopsony is to blame. Indeed, studies by Adamache and Sloan (1982), Boal and Ransom (1999), Hirsch and Schumacher (1995), and others have shown that employer concentration has little effect on the wages of teachers and nurses after controlling for city size or the general wage level.

A more recent investigation by Sullivan (1989) focused on differentiation among employers of nurses. Using data on hospitals, Sullivan estimated that if a hospital cut wages by one percent, it would lose only about 1.3 percent of its nurses immediately. This suggests that hospitals enjoy substantial power over wages. However, Sullivan also showed that a hospital would lose four percent of its nurses within three years and presumably even more in the long run. Sullivan's estimates imply that if the hospital "considers the future," it is unlikely to lower wages much more than about 10 percent below the contribution of the marginal nurse to hospital revenue.

Another recent study by Boal (2001) estimated the effects of legal minimum salaries on employment of teachers in two states. That study found that increases in legal minimum salaries tended to decrease employment, suggesting that the market for teachers was more competitive than monopsonistic.

University Professors

Several researchers have suggested that moving costs give a university monopsony power over its existing workforce because professors face moving costs. This is because professors have highly specialized skills and their potential employers (universities) are widely dispersed geographically. Now the market for newly-hired professors is surely competitive, because new hires must pay moving costs no matter who hires them. But the market for existing professors is monopsonized because professors, once hired, may require a substantial wage increase to switch universities. Moreover, since pay is usually adjusted over time for performance, universities cannot promise future salary increases at the time of original hire, as school districts do. Assuming some professors have higher moving costs than others, a modest cut in wages for existing professors will not cause them all to leave.

The model of moving costs predicts a negative relationship between wages and seniority (time spent at the same university). Ransom (1993) measured this relationship, after controlling for total teaching experience, education level, and other factors influencing professors' productivity. He did find a negative relationship -- the penalty for senior professors appeared to be roughly 5 to 15 percent. However, formal models of moving costs imply that newly-hired professors are paid more than the competitive salary level (in anticipation of later exploitation -- see Black and Loewenstein, 1991) so not all of this penalty is exploitation.

Miners in Company Towns

Textbooks often cite company towns as classic examples of monopsony, especially towns in the late nineteenth and early twentieth centuries when transportation was expensive. A company town is a small town located in a remote area with only one employer. Company towns were most common in mining, where the town's location was dictated by mineral deposits. Often the employer owned all the housing and operated all stores and other services in the town. This arrangement might seem to give the employer "control" over its workforce and monopsony power through severe differentiation of employers. However, Fishback (1992) has argued that this arrangement actually reduced living costs for employees by eliminating market imperfections in housing and retail markets. High turnover rates in company towns also cast doubt on the view that workers were "locked in" to their employers (see Boal, 1995).

Company towns were especially widespread in Appalachian coal mining in the early twentieth century. In West Virginia, for example, 79 percent of coal miners lived in company-owned housing in the early 1920s. Nevertheless, Boal (1995) showed that coal mining companies were not very differentiated and enjoyed little power over wages, at least in the long run. A one-percent cut in wages would cause at least two percent of the workforce to be lost the same year, and most of it to be lost in the long run. Thus coal miners seemed to "move with ease." Assuming employers "considered the future" with discount rates of no more than 10 percent, they would push wages down only about 5 percent, according to his estimates.

Early Textile Mill Workers

Several researchers have investigated whether America's first factories -- New England textile mills -- enjoyed monopsony power. Some researchers believe that as these factories grew in size, they were forced to raise wages in order to attract workers from farther away, at least in the early nineteenth century (Lebergott, 1960). Other researchers find no relationship between firm size and wage, but find evidence of collusion by employers in setting wages (Ware, 1966).

Still other researchers have tried to measure the rate of exploitation by comparing the value of the last mill worker's contribution to output with her wage (most mill workers were women). Implied rates of exploitation range from 9% to over 100% for particular mills in particular years. However, most estimates of the last mill worker's contribution to output are extremely imprecise, so most calculated rates of exploitation are not significantly different from zero (Vedder, Gallaway, and Klingaman, 1978). Moreover, the largest estimates are for the middle nineteenth century, not the early nineteenth century (Zevin, 1975).

Low-wage Workers

All monopsony models suggest that a modest increase in legal minimum wages should increase employment. In the United States, minimum wages affect only young and unskilled workers. Most studies of the effects of legal minimum wages in the 1970s and early 1980s found small decreases in employment for young unskilled workers, as predicted by the competitive model. However, later studies found almost no effect on employment (see Wellington, 1991) and a few studies found increases in employment as predicted by the monopsony model (see Card and Krueger, 1995). However, these latter studies are controversial (see exchange between Neumark and Wascher, 2000, and Card and Krueger, 2000) and have not convinced the majority of labor economists (see Whaples, 1996). In any case, the rate of exploitation, if positive, is probably small.

The Labor Market in General

Search models suggest that all employers enjoy some monopsony power because workers require time to find better jobs. Formal mathematical models of search, like those of Burdett and Mortensen (1989), imply monopsony power even in the long run and predict that larger firms must pay higher wages. This prediction explains the well-known "firm size-wage effect" -- on average, if firm A employs one percent more workers than firm B, it pays 0.01% to 0.03% higher wages for the same kind of workers doing the same kind of jobs (Brown and Medoff, 1989, pp. 1304-1305). Assuming the "firm size-wage effect" is due to monopsony power, firms are pushing wages down by one to three percent below the value of the contribution of the last worker to output.

On the other hand, search models also predict that most firms and jobs pay high wages and only a few pay low wages. This prediction does not fit the facts, even controlling for skill differences across workers. Efforts to fit the model of Burdett and Mortensen (1989) to actual data have been frustrated by this problem. The best such estimates to date suggest that on average wages are pushed down 13 to 15 percent due to search (van den Berg and Ridder, 1993), but these estimates are surely very rough.

Summary

The simple monopsony model provides an alternative explanation to the standard competitive model of how wages are determined. It predicts that employers will hold wages down below the value of the last worker's contribution to output ("exploitation") by limiting the number of workers they hire. But it is too simple to fit real American labor markets, so elaborations such as oligopsony or differentiation of employers are needed.

Estimates of monopsony exploitation to date in American labor markets have yielded surprising results (see Table 1 for a rough summary). Monopsony does not appear to have been important in company mining towns, a standard textbook example, or in markets for teachers and nurses, early suspects. In fact, the largest plausible estimates of monopsony exploitation to date are not for blue-collar workers but rather for professional athletes and possibly college professors.

Table 1

Estimated Rates of Monopsonistic Exploitation in American Labor Markets

References and Further Reading

Adamache, Killard W., and Frank A. Sloan. "Unions and Hospitals: Some Unresolved Issues." Journal of Health Economics 1, no. 1 (1982): 81-108.

van den Berg, Gerard J. and Geert Ridder. "An Empirical Equilibrium Search Model of the Labour Market." Vrije Universiteit, Amsterdam, Faculty of Economics and Econometrics Research Memorandum 1993-39, July 1993.

Black, Dan A. and Mark A. Loewenstein. "Self-Enforcing Labor Contracts with Costly Mobility: The Subgame Perfect Solution to the Chairman's Problem." Research in Labor Economics 12 (1991): 63-83.

Boal, William M. "The Effect of Minimum Salaries on Employment of Teachers." Unpublished paper, Drake University, 2001.

Boal, William M., and Michael R. Ransom. "Missouri Teachers." Unpublished paper, Brigham Young University, 2000.

Boal, William M., and Michael R. Ransom. "Monopsony in the Labor Market." Journal of Economic Literature 35, no. 1 (1997): 86-112.

Brown, Charles, and James Medoff. "The Employer-Size Wage Effect." Journal of Political Economy 97, no. 5 (1989): 1027-1059.

Brown, Robert W. "An Estimate of the Rent Generated by a Premium College Football Player." Economic Inquiry 31, no. 4 (1993): 671-684.

Burdett, Kenneth, and Dale T. Mortensen. "Equilibrium Wage Differentials and Firm Size." Northwestern Center for Mathematical Studies in Economics and Management Science Working Paper 860, 1989.

Card, David E., and Alan B. Krueger. Myth and Measurement: The New Economics of the Minimum Wage. Princeton, New Jersey: Princeton University Press, 1995.

Card, David E., and Alan B. Krueger. "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply." American Economic Review 90, no. 5 (2000): 1397-1420.

Fishback, Price V. "The Economics of Company Housing: Historical Perspectives from the Coal Fields." Journal of Law, Economics, and Organization 8, no. 2 (1992): 346- 365.

Hicks, John R. The Theory of Wages. London: Macmillan, 1932.

Hirsch, Barry T., and Edward Schumacher. "Monopsony Power and Relative Wages in the Labor Market for Nurses." Journal of Health Economics 14, no. 4 (1995): 443-476.

Kahn, Lawrence M. "The Sports Business as a Labor Market Laboratory." Journal of Economic Perspectives 14, no. 3 (2000): 75-94.

Lebergott, Stanley. "Wage Trends, 1800-1900." Studies in Income and Wealth 24 (1960): 449-498.

Link, Charles R., and John H. Landon. "Market Structure, Nonpecuniary Factors and Professional Salaries: Registered Nurses." Journal of Economics and Business 28, no. 2 (1976): 151-155.

Luizer, James and Robert Thornton. "Concentration in the Labor Market for Public School Teachers." Industrial and Labor Relations Review 39, no. 4 (1986): 573-84.

Neumark, David and William Wascher. "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Comment." American Economic Review 90, no. 5 (2000): 1362-1396.

Pigou, Arthur Cecil. The Economics of Welfare, second edition. London: Macmillan, 1924.

Ransom, Michael R. "Seniority and Monopsony in the Academic Labor Market." American Economic Review 83, no. 1 (1993): 221-231.

Robinson, Joan. The Economics of Imperfect Competition, second edition. London: Macmillan, 1969.

Scully, Gerald W. "Pay and Performance in Major League Baseball." American Economic Review 64, no. 6 (1974): 915-930.

Sullivan, Daniel. "Monopsony Power in the Market for Nurses." Journal of Law and Economics 32, no. 2 part 2 (1989): S135-S178.

Vedder Richard K, Lowell E. Gallaway, and David Klingaman, "Discrimination and Exploitation in Antebellum American Cotton Textile Manufacturing." Research in Economic History 3 (1978): 217-262.

Ware, Caroline. The Early New England Cotton Manufacturers: A Study of Industrial Beginnings. New York: Russell & Russell, 1966.

Wellington, Alison J., "The Effects of the Minimum Wage on the Employment Status of Youths: An Update," Journal of Human Resources 26, no. 1 (1991): 27-46.

Whaples, Robert. "Is There Consensus among American Labor Economists? Survey Results on Forty Propositions." Journal of Labor Research 17, no. 4 (1996): 725-34..

Zevin, Robert B. The Growth of Manufacturing in Early Nineteenth Century New England. New York: Arno Press, 1975.

Zimbalist, Andrew. "Salaries and Performance: Beyond the Scully Model." In Diamonds Are Forever: The Business of Baseball, edited by Paul M. Sommers, 109-133. Washington DC: Brookings Institution, 1992.

Citation: Boal, William and Michael Ransom. "Monopsony in American Labor Markets". EH.Net Encyclopedia, edited by Robert Whaples. January 24, 2002. URL http://eh.net/encyclopedia/article/boal.monopsony