When Might Binding Minimum Wages *Reduce* Unemployment?
Even then, are minimum wage laws still advisable?
Last Friday, I published an article here to provide my views on the policy proposals of leadership candidates for the federal NDP. Here is one thing I wrote:
But in terms of minimum wages, I want to point out that contrary to the standard ECON 101 treatment of minimum wage laws, it is not necessarily true that they cause unemployment, because that basic model assumes perfect competition in labour markets. On the other hand, when employers have “monopsony power” — which means one buyer of labour at the extreme — binding minimum wages can actually increase employment by forcing employers to raise wages closer to the perfectly competitive ideal.
With all of that in mind, I would be hesitant to raise minimum wages unless we are very confident there is significant monopsony power in the labour market. I would generally prefer market-based approaches to raising wages such as investing in better healthcare and education so workers are more productive, and therefore command higher wages in the labour market.
That part of the article raised some questions for one of my long-time readers, and I believe they are worth answering here because others might have the same ones. In short, they are:
How can we accurately determine when monopsony power is strong enough to justify minimum wages?
Businesses are known to engage in anti-competitive acts such as price-fixing, regulatory capture, etc., but do these kinds of practices exist in labour markets? If not, how do we assess instances where labour decisions may be distorted due to corporations all being on the same page, despite not fitting the formal definition of a monopsony or other market failure?
I will answer the first question today and then do some more research before I answer the second question.
First, I want to be clear on how monopsony power affects labour markets in terms of equilibrium wages and unemployment: similar to how a monopoly seller of a good or service will sell too little for too much (relative to the perfectly competitive ideal), a monopsonistic employer will hire too few labourers for too little in wages (relative to the perfectly competitive ideal).
In other words, whether an employer with market power is buying labour or selling goods and services, they are making excess economic profits at the expense of their employees and/or customers.
Next, to determine whether monopsony power exists, the most accurate method is to estimate the elasticity of labour supply.
In a perfectly competitive labour market, there are so many identical employment options that this elasticity is infinity. In other words, if an employer lowers its wage rate below the competitive level by even one cent, then it will lose all of its employees to other employers. Employees have absolutely no ties to that employer apart from how much it pays relative to other employers.
In a perfect monopsony (one and only one employer), the elasticity is zero, which means the employer can lower its wages and lose no employees at all. Employees either take the wage they are offered or they are unemployed.
Therefore, the closer the elasticity of labour supply is to zero, the more monopsony power the employer enjoys.
However, estimating this elasticity requires good data, which can be difficult to obtain without a court order. So before I tried to obtain that kind of data, I would first look at how many employers exist in a given market (employer concentration): the fewer employers exist in that labour market (the higher the concentration), the more monopsonistic is the market.
For example, there are essentially three stable airlines in Canada which can serve domestic routes: Air Canada, WestJet, and Porter Air. Therefore, I expect the labour market for pilots and flight attendants to be an “oligopsony” (analogous to “oligopoly” when talking about sellers of goods and services). However, Air Canada is by far the dominant employer of the three, so I am very confident it has significant monopsony power in the market for pilots and flight attendants.
We can also look at specific regions or cities to see if there is a dominant industry in those places, and therefore a dominant source of employment. The auto industry in Windsor strikes me as one, since I believe it is almost all the city has for employment. There is also the university, but many academics will move just about anywhere within reason to get a job as a professor, while autoworkers likely have fewer options outside Windsor given their skill sets (more on that point later). So automakers in Windsor likely have oligopsony power.
But note that monopsony/oligopsony power is more accurately defined as existing when there are free markets with absolutely no outside intervention. Therefore, I still see no need for governments to set minimum wages in industries such as airlines and the auto sector because they have strong unions, which themselves are responsible for pushing wages up closer to the competitive ideal.
Other examples come from Chris Ragan’s Microeconomics (Fourteenth Canadian Edition) where he writes on page 344:
Although monopsony is not very common, it sometimes occurs in small towns that contain only one industry and often only one large plant or mine. For example, Iroquois Falls and Dryden in Ontario are small towns in which the principal employer is a single firm that operates a newsprint plant. Although both towns provide alternative sources of employment in retailing and service establishments, the large industrial employer has some monopsony power over the local labour market. Other examples of monopsony power include cities in which a single school board is the sole employer of teachers or a regional health authority is the sole employer of nurses.
A final example that comes to mind is the oilsands in Fort McMurray.
As you might expect, there are additional indicators of monopsony power apart from employer concentration. Specifically, Carmen Sanchez Cumming wrote the following for the Washington Center for Equitable Growth:
Research shows that there are a number of factors that can constrain someone’s ability or desire to switch jobs. Employer concentration, the time and effort it takes to find another job, and individual preferences or needs unrelated to pay, such as looking for part-time employment due to care responsibilities, are some of those factors. Other factors include fears of losing employer-provided benefits, noncompete contracts, economic downturns, and discrimination.
I highly recommend reading that entire article for much more information regarding how economists measure monopsony power in labour markets.
Given everything I have written above, I now want to revise my argument quoted at the beginning of this piece, where I wrote “I would be hesitant to raise minimum wages unless we are very confident there is significant monopsony power in the labour market.” I am now inclined to say I would be hesitant to raise minimum wages even if there is significant monopsony power in the labour market.
That is because minimum wages tend to apply uniformly across entire provinces, which are much broader than any single labour market. So while a binding minimum wage could decrease unemployment in labour markets which are monopsonistic, they would simultaneously increase unemployment in more competitive labour markets within the same province. The overall effect on unemployment might then be to increase it as labour market conditions can vary significantly across a single province.
It could be even worse if the federal government increased the national minimum wage (which does exist in Canada at a rate of $17.75/hour, but only for federally-regulated industries). Not only do labour market conditions vary significantly across the country, but so do costs of living; a “living wage” in one part of the country could be considered “poverty wages” in another one.
Thus, policies aimed at reducing monopsony power in labour markets should be more targeted at local labour markets, which again is where industry-specific unions come in handy; they understand their specific labour market conditions much better than any government, so they are the best ones to negotiate wages, benefits, and workplace conditions for their members.
And when unions are not in the picture, governments should try to make labour markets more competitive rather than figuring out optimal wages in local markets. For example, governments can legislate policies and develop programs to help reduce the costs of the job-search process (including time costs), assist with care responsibilities (e.g., daycare), and reduce workplace discrimination, in addition to competition policies which forbid anti-competitive non-compete contracts.
Furthermore, social programs such as universal healthcare already help make labour markets more competitive because a person does not feel so tightly tied to a specific employer for their benefits. Of course, employers still do offer benefits which are not covered by governments, but the point is these programs help make labour markets more competitive than they otherwise would be.
For more of what I previously wrote on monopsony power, please read the article at the link below:
While reviewing that article, I was reminded of how little Economics textbooks seem to cover monopsony, even Labour Economics books. One explanation is the authors of those books flat-out argue monopsonies are rare in real life (at least in Canada). In fact, they claim most empirical studies of the effects of binding minimum wage laws on employment — including Canadian studies — have found unemployment increases with minimum wages, thus suggesting the competitive model is often a reasonable model to apply in the real world.
But it might also be because industries in Canada that are monopsonized tend to also be unionized, so employers do not reap the benefits of the monopsony power they would have without the unions.
In my previous article on monopsonies, I also noted I do not think about monopsony power a lot, so I need to be more conscious about it in all of my writings. That note-to-self remains relevant today.
And that leads me to my reader’s other question regarding collusion between employers in labour markets. I am glad they brought it up because I rarely even think of such a thing; throughout my education and career, I have tended to focus on collusion between sellers of goods and services. But now that this reader mentioned it, it is conceivable that employers within a market — particularly non-unionized industries — could get together to coordinate their hiring practices so employees cannot pit them against one another. For example, they might agree to not poach employees from each other, or explicitly coordinate the wages they pay employees.
Furthermore, if they are colluding, I expect it would be even more difficult to prove than collusion in the sales of goods and services, because sale prices are often public so one can see prices moving uniformly across competitors. But employers often keep their wages strictly secret, even so far as to forbid employees in the same company from comparing wages with one another, so it would be hard to even begin to make a case of collusion in labour markets.
I will do more research in the Industrial Organization, Competition Policy, and Antitrust literatures, and then write more about it in another issue of this newsletter. While I was writing everything above, I started to remember reading about such anti-competitive acts in the labour market many years ago, so this next article promises to be a good one.
Thank you to that reader again for their excellent questions — they have asked many other great questions in the past which have resulted in other fun issues of this newsletter — and I invite any and all of you to also ask me any questions you might have which are related to Economics. It truly is a lot of fun to answer them.
It also means I do not have to work so hard coming up with topics on my own! :-)
Finally, if you find what I write valuable, please consider a paid subscription. As an added bonus, paid subscribers will be given priority in terms of answering Economics-related questions, especially ones that involve research. Nonetheless, I am happy to answer any Economics-related questions anyone has for me!
I was interested in your note about employers potentially coordinating to keep wages low. You might find it interesting that Ottawa actually criminalized this recently. The Competition Act was amended in June 2023 to specifically ban wage-fixing and no-poach agreements (where companies agree not to hire each other's staff). Before that change, it was mostly treated as a civil matter. It suggests the government believes this type of "shadow monopsony" is happening enough to warrant jail time rather than just fines. I’ll be watching to see if the Competition Bureau actually charges anyone under the new rules.