If You're So Smart . . .

Jon M. is correct. Don also suggested buying into an established franchise that already has the business ops and value proposition figured out.

Buy a McD’s. You should be able to do so at market rates and then make money by exploiting the knowledge of the labor market prices.

I propose a criticism to Don’s argument: the opportunity cost may not be worth the gain made on the monopsony arbitrage. It doesn’t seem like magnitude of the difference between the market rate and productivity rate is talked about often, but is important.

You have one type of knowledge–about labor market prices–and you don’t know anything else about McD’s or the industry. Your odds will not be good.

You could share the information about labor market prices with someone who has the knowledge you don’t and they could exploit that knowledge. So why doesn’t that happen?

I don’t know how much a lot of monopsony power is. I know two things: (1.) it’s been corroborated in other non-minimum wage studies, and (2.) it’s one of the only things I can come up with to explain why we don’t find the expected negative effect in the empirical literature on the minimum wage.

As an empiricist those loom pretty large in convincing me there’s monopsony power in play in these labor markets. It’s also just a very sensible theory. It would seem odd for there not to be some such power.

The nature of that monopsony power is a more complicated question – I’ve got thoughts on that recently: http://factsandotherstubbornthings.blogspot.com/2013/10/monopsony-and-expectations-about.html

@Pajser- Not really. Tu quoque “attempts to show that a criticism or objection applies equally to the person making it.” There is not an argument about *hypocrisy* here at all, there is an argument that asks for an explanation why, if a massive opportunity that could be exploited exists, *nobody* is exploiting it.

The explanation appears to be that the people who know this opportunity exist would rather horde this information and not use it than share it with people who have other information they don’t, who could use it. Well okay, I guess that’s fair. It’s kinda dumb, but it’s fair.

Boudreaux wrote

If an academic tells you that his research finds that the price of … stock .. is too low… The first question I would ask him is “How much of that stock are you buying?” If the scholar tells me “none,” … I would dismiss his research on this front.

According to wikipedia,

Tu quoque … or the appeal to hypocrisy, is a logical fallacy that attempts to discredit the opponent’s position by asserting the opponent’s failure to act consistently in accordance with that position;

Isn’t it an instance of that fallacy?

I completely disagree with David Henderson.

It’s hardly unheard of for academic economists to put their money where their mouths are by starting their own investment and advisory firms, notably Thaler, Scholes, Fama, Shiller and Taleb.

At the very least an economist could start a consulting business that identifies the areas with the most edge for would-be investors in businesses that use low-skilled labour. That’s totally within the skill set of an academic economist.

Sorry, David, I can’t disagree with Don on this one. Too much evidence against your position. If there really is such an opportunity, some economist would be taking advantage of it either by starting an investment business that invests in such ventures or a consulting business that advises entrepreneurs. For Don to be correct every economist who insists there are persistent monopsony conditions doesn’t have to do it, only an economist who insists monopsony conditions persist long term has to do it. Show me ONE.

re: “You don’t know the business. You know one thing: this apparent loophole you’ve found. But you don’t know about financing cars, financing transportation, selling cars in the United States, etc.”

Right. That’s why you partner with people who do know that part of the business. Come on, David! Voluntary cooperation for the mutual benefit of all parties!

I run a financial business which is subject to a slew of regulations, taxes by every parasitic level of government, to the law, and requires massive investments in technology. I don’t know anything about building out networks, laying cable or building computer systems. I’m not an expert on regulation or taxes or even tax treatment of all trading strategies. I don’t know the laws and every regulation, etc. I rely heavily on algorithms, but I can’t even program my way out of a wet paper bag in Visual Basic! I don’t even know much about investing.

All I know is how to identify statistical arbitrage opportunities in the narrow space in which I’m an expert. I employ an army of lawyers, accountants, tech people, network specialists, engineers, electricians, and programmers and an operations manager to do the rest. Before I start a new business, I consult with all of them and then run the numbers again.

Since when did you have to be an expert in all aspects of a businesses to get into it? You could have just joined forces with someone who was in the business of importing and selling cars. Perhaps you would have found out you can’t actually exploit that loophole for xyz reasons (not everything that appears to be an arbitrage is exploitable because of carry costs or laws that impede it or whatever). But, your giving up on the idea without fully exploring it is not evidence that it was a bad idea or that you couldn’t have profited from it just because you’re not an expert on every aspect of the business.

Methinks,
It’s a surprise to learn that folks who claim to believe and understand the principle embedded in the “I Pencil” essay, do not automatically understand how it can be applied to any field. To bad David didn’t jump on his opportunity.

GeorgeNYC:

Your argument proves too much. It applies to ANY profit opportunity – say, the arbitrage opportunity to buy pork bellies today at prices that a commodities speculator judges to be too low in order to sell tomorrow when (that speculator hope) the price price of pork bellies will be higher.

The proponents of the argument that justifies legislated minimum wages on the grounds that there allegedly exists monopsony power in the market for low-skilled workers implicitly assume that the excess returns from that monopsony power have not been competed away on some other margins. If this assumption is correct, then a profit opportunity exists to be exploited. Sure, eventually the exploitation of that profit opportunity will compete it away. That is as it should be, and as basic economics predicts. But, again, there’s nothing at all unique in this way about the profit opportunity alleged to exist because of monopsony power in the labor market.

@David – I thought you were criticizing the position of starting a business from scratch.

That has a great deal of risk and skill variables that would not likely be offset by the value to be gained on the monopsony knowledge.

McD’s (and other established franchises) turns people from all backgrounds into profitable restaurant operators, so they reduce the risk and skills variables considerably.

I think this gets back to my last point, a point that isn’t addressed often — for the academics who believe the monopsony argument, what is the magnitude of the profit opportunity?

Don concedes that they may not believe that it’s large enough to justify starting a business from scratch.

And maybe it’s not large enough to buy into an established franchise.

But, his point is that academics should feel it is large enough to, at least, build a consulting business around.

But, that depends on the potential economic profit opportunity.

Daniel,

Please explain why my argument “is weak to begin with?” Do you not believe that monopsony power created by upward-sloping supply curves (rather than by legal restrictions) present profit opportunities? If not, why not? And I see nothing about invoking frictions of the sort that Alan Manning invokes to undermine my argument. ALL markets are full of frictions, and yet entrepreneurs routinely exploit prevailing profit opportunities.

The Manning book, as I read it, is all-too-typcial of much modern economics. It sets up as a straw man a perfect, fritionless market and then concludes that because in reality there are no such thing (whoa! who knew?!), the case for free markets is thereby undermined or significantly weakened.

The case for markets, properly argued, recognizes the profit opportunities that exist because of these frictions and ‘imperfections.’ Read Coase, for example, for a host of reasons and examples of how real world markets are best understood as attempts to get around and deal with such frictions and imperfections.

Lay your hands and eyes on almost any randomly chosen issue of the Journal of Law & Economics from the 1950s through at least the early 1980s and you’ll find there a cascade of articles that document real-world business practices and institutions that exist in order to deal with market frictions and ‘imperfections’ – frictions and ‘imperfections’ whose existence was argued by earlier generations of Alan Mannings to ‘prove’ that markets don’t work and, therefore, allegedly require regulation or taxation or subsidies by the wise geniuses in government.

Manning says nothing new; it’s old stale wine – nay, vinegar – in a somewhat new bottle. The label of that new bottle might impress you, but the contents have been sampled long ago and exposed as bitter and misbegotten.

Read Hayek and other Austrians – or read them more carefully. All of their arguments recognize from the get-go the sorts of frictions that Alan Manning triumphantly claims to have discovered to be in play in labor markets.

Don –
This’ll be about the fourth time I’ve explained it – we’ve emailed, I’ve commented on your blog, I’ve commented on my blog, and now I’ve commented here. So I’ll let that account stand.

The question is what is the nature of the upward sloping supply curve. If it is market power associated with the competitiveness of the market, then entry is obviously going to make a difference. But that begs the question of why their is market power.

Most economists today cite fixed costs and turnover costs (Manning) or asymmetric information (Acemoglu and Pischke) as the source of this market power and it seems to me that entry is not as obvious a remedy to these sources of market power.

re: “ALL markets are full of frictions, and yet entrepreneurs routinely exploit prevailing profit opportunities.”

The question isn’t whether profit opportunities are exploited. Of course they are. The question is whether they are eliminated. Unless you can compete turnover costs down to ZERO you are going to have monopsony power.

re: ” It sets up as a straw man a perfect, fritionless market and then concludes that because in reality there are no such thing (whoa! who knew?!), the case for free markets is thereby undermined or significantly weakened.”

As far as I know, Manning doesn’t present a case against free markets. I could be misremembering.

re: “The case for markets, properly argued, recognizes the profit opportunities that exist because of these frictions and ‘imperfections.’ Read Coase, for example, for a host of reasons and examples of how real world markets are best understood as attempts to get around and deal with such frictions and imperfections.”

Again, I don’t think Manning is and you and I certainly are not arguing over markets or Coase. I am on board in both cases. If you think there is some reason to think all monopsony power is competed away by these explanations, though, I think that needs further justification. I see plenty of reason to think that the point of markets is to get around these imperfections. I don’t see any obvious reason to think they necessarily eliminate them.

re: ” earlier generations of Alan Mannings to ‘prove’ that markets don’t work”

As far as I know Manning thinks markets work, right? Your whole comment is confusing me now.

re: “Read Hayek and other Austrians – or read them more carefully. All of their arguments recognize from the get-go the sorts of frictions that Alan Manning triumphantly claims to have discovered to be in play in labor markets.”

Right… I was never under the impression that they didn’t, Don.

You’ve got a very odd take on the nature of the discussion, I think.

Here’s the opening of Princeton University Press blurb for Manning’s book on monopsony:

“What happens if an employer cuts wages by one cent? Much of labor economics is built on the assumption that all the workers will quit immediately. Here, Alan Manning mounts a systematic challenge to the standard model of perfect competition. Monopsony in Motion stands apart by analyzing labor markets from the real-world perspective that employers have significant market (or monopsony) power over their workers. Arguing that this power derives from frictions in the labor market that make it time-consuming and costly for workers to change jobs, Manning re-examines much of labor economics based on this alternative and equally plausible assumption.”

The case for markets was never built on the supposed reality of perfect competition; the case against minimum-wage legislation (and other interventions that Manning discusses) was never built on the assumption that a one-cent cut in wages results in all workers quitting.

But you continue to believe that the excess returns caused by frictions that result in W<MRP are somehow not all competed away. (You must believe this proposition to be true, otherwise a hike in the minimum wage would, for example, cause at least some firms’ profit rates to fall below normal and eventually lead to those firms going bankrupt. Or, for another example, cause firms to worsen the work conditions of the workers that you think minimum-wage legislation helps.)

I don’t buy that proposition that these excess returns continue to exist period after period. It’s simply too unbelievable – and, I repeat, if you DO believe it, you’ve identified a profit opportunity. Sure, it’s not a profit opportunity as easily exploited as literally spotting a $100 bill lying on the sidewalk at your feet. Few profit opportunities are so obvious. But it IS a profit opportunity. That is, the very frictions that you claim might perhaps sometimes justify minimum-wage legislation are an opportunity for clever entrepreneurs to exploit in order to earn profits.

You might say that that those opportunities are too small to worry about. Then I’d say the degree to which low-skilled workers are underpaid is too small to worry about – or too small to trust to be corrected with a necessarily surgically designed minimum-wage hike.

You might, in contrast – and I’m sure correctly – describe yourself and the likes of Profs. Krugman and Krueger to be incapable of figuring out how to create market opportunities to exploit even large-enough-to-worry-about gaps between W and MRP. But you and others like us who know nothing about the details of organizing and running real-world businesses are not the only types of people around.

You still haven’t explained why such profit opportunities (assuming them to be large enough to cause genuine problems for low-skilled workers) continue to be addressed only by politicians with minimum-wage legislation and not by entrepreneurs and investors who stand to make a killing by figuring out ways to reduce these ‘frictions’ in order to employ this labor at wages closer to its MRP.

Finally, I just don’t buy the argument that frictions in this market are all that great. What is stopping the McDonalds on one corner from bidding away underpaid workers from the Burger King on the other corner? Sure, neither restaurant faces a perfectly horizontal supply curve of labor. Manning’s cartoon portrait of economics is incorrect. But what’s the big ‘friction’ of one firm competing away workers from other firms? Or of an entrepreneur setting up a new firm – it happens all the time – and hiring new workers and offering those workers pay higher than they are paid by their current employers?

Sorry, buddy, but the monopsony argument – the argument about monopsony in the real world and not about how reality doesn’t look like some ridiculous cartoon in a straw man textbook – doesn’t pass the smell test.

GeorgeNYC:

You write “My [GeorgeNYC’s] argument is that the monopsony does not allow for an arbitrage because of the position of the monopsonist gives it an advantage that prevent such an arbitrage opportunity from working.”

Why not? The monopsonist, by assumption, is paying W for an hour of a laborer’s work and getting an amount of revenue of W+X in return for that payment. The “+X” is a profit opportunity for another employer to exploit.

If an entrepreneur notices that Acme Corp. is paying lots of its workers W and getting for each hour of work W+X revenue, that entrepreneur has an incentive to (say) start a new firm to employ such workers and to bid those workers away by offering to pay them W+Y per hour (where Y is perhaps less than X). The first firm might respond by either matching or even upping that wage offer. In this way, wages get bid up to W+X (just where these wages should be).

Scholars such as Daniel Kuehn will allege that frictions prevent this process from working, or from working fully enough to justify a hard and fast rule against any government intervention into labor markets. And my challenge to him would be to explain why. Why will entrepreneurs not grasp for and experiment with opportunities to exploit the prevailing profit opportunity of W less than MRP (“marginal revenue product”) (or W less than W+X).

There might well be frictions that prevent some workers from moving away from their homes in small towns such as Gadsden, Alabama or Troy, New York. But what frictions prevent upstart firms from entering Gadsden and Troy and competing these workers away from their current exploiting employers? Entry remains largely free. If W less than MRP is large enough, profit opportunities exist.

And it’s not clear to me just how stuck are workers in particular locales. I doubt the empirical significance of frictions here, at least in modern-day (albeit pre-2008 slump) America. Some workers are ‘stuck,’ but mostly as a matter of choice – e.g., they love their home town or they must care for their aging parents or their spouse has a job in that town. Some workers simply lack initiative to move elsewhere. But, again, if W<MRP is large enough, profit opportunities exist.

To the extent that W less than MRP is too small to elicit more competition for low-skilled workers, then

(1) it’s unlikely that minimum-wage legislation will improve matters, as such legislation would have to be surgically designed and implemented even to conform to the demands of the textbook model; a too-high wage hike would cause some workers to lose their jobs;

(2) because minimum-wage legislation does nothing to get rid of the small frictions that result in the small remaining gap between W and MRP – that is, because minimum-wage legislation does nothing to treat ‘monopsony power’ itself (it treats only a symptom of such power) – employers lucky enough to be protected by these frictions will have ample opportunity to adjust, in response to a higher minimum wage, their workers’ employment contracts and conditions on other margins. Fewer breaks; less leniency in leaving early or doing personal texting; fewer vacation days. The possibilities for such offsetting adjustments are quite extensive;

and

(3) because there is likely competition in the output market, whatever small excess returns these employers enjoyed as a result of their being able to employ workers at wages less than MRP will be competed away on other margins. A higher minimum wage will thus reduce these firms’ profit rates; such rates will fall below normal, causing these firms to adjust to a higher minimum wage in order to restore their rates of profits to levels consistent with survivability. Some firms likely will not be able to adjust; they’ll go bankrupt and, hence, their workers will lose jobs. Other firms will adjust by scaling back their operations – also likely causing some job losses. And yet other adjustments might be made in the form of further worsening of the job contracts and conditions for minimum-wage workers.

There is no doubt that one can draw pretty pictures under a plethora of assumptions in order to show that a minimum-wage improves the lot of all low-skilled workers. But the plausibility of such assumptions holding in reality – especially given the refusal by proponents of the monopsony model to themselves try to profit from the profit opportunities that they themselves assume to exist in the labor market – is simply too incredible to take seriously.

Thanks L!

Don –
re: “The case for markets was never built on the supposed reality of perfect competition”

Nobody is making a case against markets that I am aware of.

Reread the blurb you quote more carefully. Nobody said anything about that.

Much of labor economics ignored monopsony cases. Manning says that’s bad. He’s right. I would have thought you’d agree that an economics based on “perfect competition” is silly. Free competition is not “perfect” competition.