Eric Posner on Monopsony
I recently criticized Don Boudreaux’s two major arguments against legal scholar Eric Posner’s claim that monopsony in U.S. labor markets is widespread. But I do agree with Don that Posner’s case is defective.
Economic theory says that when a pool of workers has only one potential employer, or a small number of potential employers, those workers will be paid below-market wages.
Actually, economic theory doesn’t say that. I’ll put aside the quibble that wages couldn’t be below-market because whatever we’re observing is the market. It’s clear from context that Posner means below the wage that would be paid in a competitive market, so that’s what I’ll consider.
(By the way, if you follow the link in the Posner quote above, it will take you to a lengthy study on monopsony by former President Obama’s Council of Economic Advisers. I critiqued that study here, here, here, and here.)
Posner is right that economic theory says this is true when there is only one potential employer. But it’s silent on the issue when there are “a small number of potential employers.” There are often industries in which there are only a few firms and these few compete aggressively in the output market. It’s hard to believe that they wouldn’t compete aggressively in the market for inputs, in this case, labor.
In his article “Monopoly” in David R. Henderson, ed., The Concise Encyclopedia of Economics, economist George Stigler referenced a study by fellow University of Chicago economist Reuben Kessel on underwriter spreads in the bond market. Kessel found that when there were 20 bidders, the spread (the price charged by the underwriters) was $10 and when there was one, it was $15.74. That latter price is consistent with Posner’s claim. But, Kessel noted, just adding one extra competitor brought the spread down to $12.64, a major drop. Having 6 competitors brought it down to $10.71, almost all the way to the spread charged by 20 competitors. In short, 6 competitors led to a very competitive result. In most people’s eyes, 6 is a “small number of potential competitors.”
In one paper, José Azar, Ioana Marinescu, Marshall Steinbaum and Bledi Taska found that more than 60 percent of labor markets exceeded levels of concentration that are regarded as presumptive antitrust problems by the Department of Justice.
Ok, but that’s not enough evidence. That’s simply evidence that the Department of Justice has a presumption. Has the Department of Justice dealt with Stigler-type reasoning and Kessel-type empirical analysis? (The paper he cites does have evidence that concentration is correlated with lower wages, but I haven’t examined it.)
Posner does give some good evidence, writing:
For example, Elena Prager and Matt Schmitt examined hospital mergers and found that when hospitals expand through mergers and gain significant market power, the wage growth of employees declines. Notably, this decline affected skilled health care professionals like nurses — but not administrators and unskilled staff members like cafeteria workers, who could easily find jobs outside hospitals.
I wonder if Posner’s aware of two major factors that lead to concentration in the medical sector. One is regulation. The medical industry is one of the most regulated industries in America and became even more regulated with ObamaCare. When an industry is regulated, there are typically what I call “economies of scale in compliance.” A firm with 10 times the size of another firm bears costs of compliance that are less than 10 times the cost for the other firm. Even without mergers, that knocks out small firms and it also leads to mergers so that firms can take advantage of those economies of scale in compliance.
The other factor is Certificate of Need Regulations that many states have. The acronym is CON, and it’s a great acronym because it is a con. These regulations prevent surgery centers from arising to compete with hospitals and prevent hospitals from expanding to compete with other hospitals. When a surgery center or a hospital goes before a regulatory board to get government permission, guess who often intervenes to object to the new competition? That’s right: the current competitors.
In fact, some of the toughest CON regulations are in Posner’s state of Illinois. And in his 2008 book, Code Red, a health economist just up the street from Posner, David Dranove of Northwestern University, exposed some of the bad effects of CON regulation in Illinois. Prices and wages aren’t the only thing that matter. Dranove writes that due to CON regulations:
Illinois hospitals today are located where Illinoisians lived in the 1950s.
Posner also contradicts himself in his last paragraph, writing:
Labor monopsony affects people at all income levels, but it is a particular problem for lower-income workers and people living in stagnant rural and semirural parts of the country.
But lower-income workers tend to be less specialized. They tend to be the unskilled workers whom Posner says are not affected by monopsony. What gives?
Note: The picture at the top is of George Stigler, whose work is referenced in this post.