Some thoughts on the origins of monopsony and minimum wages

For the past couple of weeks, I've been thinking about the problem minimum wages in terms of a game, and I think there is a kernel of good idea here. 

There has been a lot of discussion recently about how unskilled, low wage workers are faced with a job market where the employers have the monopsony power to pay wages below the competitive market rate. Since a monopsony occurs when there is a single payer (the employer) and a large market of sellers (unskilled labor), the employer is able to pay wages below the competitive wage rate.

Let's say that we have two firms in perfect competition producing commodities that are perfect substitutes. For the sake of argument let's say that they are hamburger chains A and B. The cost of their product is a combination of the variable costs of their materials, their labor costs and their fixed costs of operation (building, utilities, etc.). They want to keep their costs to a minimum so that they can compete for a share of the available market. So any thing which causes their costs to rise will mean that they have to raise their prices. But if A raises his prices and B doesn't, then B will take market share away from A. If their fixed costs or the cost of their ingredients increase, then A and B are both affected equally. They both raise their prices by an equivalent amount, and their market shares remain equal. 

Score (0,0).

Now think about the problem of their labor costs. If both A and B Hold their wages steady then neither suffers a loss.

So long as there is a ready supply of low skill labor, there is no pressure for them to raise wages. In fact, there is a downward pressure on their labor costs even under conditions where the wages they pay are below what the labor market would indicate. The reason is that if A raises his wages then B will want to hold his wages. That will allow B to take some share, +a, of the market away from A who loses -a. The risk is obviously symmetric under an exchange of the labels A and B. 

Score (+a,-a).

If labor costs are at or above the market equilibrium, then if both A and B raise their wages they may both suffer a small loss, -b. But that loss is likely to be smaller than if they raise their wages and their competitor doesn't. The risk of the larger loss in the asymmetric wage rise case causes both A and B to keep their wages below the equilibrium. This is possible because there is always a fresh stream of new, unskilled labor. So long as the rapid turnover in their labor supply is small enough that the costs of training are below the costs due to rising wages, it is better for them to Hold wages steady. 

Score (-b,-b).

If both A and B Raise wages and the labor costs are below the market equilibrium, then neither will suffer a loss because the market hasn't changed. In fact, in this situation there could even be a net positive benefit +b to both A and B if they raised their wages because of an increase in the size of the market! 

Score (+b,+b).

Wages are below equilibrium         A B H R H 0,0 -a,+a R +a,-a +b,+b

Wages are above equilibrium         A B H R H 0,0 -a,+a R +a,-a -b,-b

In this case, the monopsony emerges from a sort of Prisoner's Dilemma. Even if they wanted to raise wages, they can't since their competitor can defect and hold their wages, stealing market share. So the monopsony in this situation isn't the result of any sort of collusion or ill will on the part of the employers. They're stuck in a Nash equilibrium that hurts all parties involved.

An increase in the minimum wage provides a way for both companies A and B to increase wages without risking the adverse effects of a competitor defecting and stealing market share.

The idea needs more work, but I think it's on the right track.

The Fourth Turning

After the election, I immediately thought of William Strauss and Neil Howe's books on their generational theory of American history. Friday night, while looking for an author to feature, I did a search on Amazon's trending books. To my astonishment, I noticed that sales of The Fourth Turning had increased by over 1000%.

For those not familiar with Strauss and Howe, I will summarize quickly. They argue for a cyclical pattern to American political culture that is four "generations" long. A generation is roughly 20-25 years. That is roughly the length of time between when a person is born and when they begin having children of their own. Each generation comes of age in and reacts to the world in which they grew up. They then try to correct for what they perceived to be the failures of their childhood, swaying the culture in a new direction.

In the generational theory, people essentially go through four life stages. Childhood and adolescence, young adulthood-child rearing (spent out of power), middle age and prime working age (spent at mid-level power positions), and finally late middle age to old age when they are grandparents and cultural icons/political leaders. (Some of this is my own nomenclature.)

Cyclical theories of history are a dime a dozen. They go back to at least Plato. Most of these theories are people looking for patterns in very noisy data and finding whatever they wish to find. In other words, complete BS. But the thing that I learned from their books was to look at the childhoods of various political leaders in order to understand their behaviors. For instance, Theodore Roosevelt and Woodrow Wilson were contemporaneous. But Roosevelt came up during the American Civil War in New York, while Woodrow Wilson spent his childhood during the American Civil War in the south. It makes their imperialist vs. pacifist leanings understandable. So now, when reading biographies, I always try to understand the world in which the subjects came of age.

Should you expect a cyclical model to hold? I have no idea. Probably not. However, the model that Strauss and Howe offer has a very natural set of time scales associated with it. The length of time between an individual's birth and their child rearing years and the length of a human life fit their model.

People will always rightly object to describing the entire population as being equivalent to the population average. But that doesn't mean that you can't have a cyclical behavior. A weak sloshing mode in public attitudes may result in a movement of the average which is never far from the center but which can have significant effects.

Perhaps I should explain a sloshing mode oscillation. Imagine extending your hands out before you palms up. Someone places a cookie sheet on your hands and fills it to the brim with water. Now you try to walk across the kitchen carrying the cookie sheet. No matter how careful you are, the water will begin to oscillate in the pan, shifting back and forth. That's the sloshing mode. Small inputs can generate changes in the distribution of water even though no individual drop of water ever moved far from where it began.

So what does this have to do with the election? Two things. First, Strauss and Howe argue that their cycles generate cultural crises every four generations, or 80-90 years. The last crisis was the Great Depression and World War II. They argued that the next crisis would come somewhere around 2010-2020. The twenty to 25 years prior to the crisis they termed the Great Unraveling when warring cultural factions would essentially be tearing the country apart. (They wrote in the early nineties.) The Great Recession and the current election fall right on top of their crisis time frame, and I thought of it immediately after the election. That's one point.

Now the second point. I was curious why there had been such an increase in the purchase of The Fourth Turning: An American Prophecy on Amazon. So I did a search on Google News for the title. It turns out that the book is one of Steve Bannon's favorites, and he sees himself as being one of the leaders destined to guide the country through this great crisis. Now I personally see him as part of the crisis, not it's solution. But that's just my opinion. I keep thinking of the old saw, "A villain is the hero of his own story."

That's the problem with prophecies. They're so ambiguous as to be completely useless. We find ourselves in a Greek tragedy worthy of Aeschylus or Sophocles. Who is the villain will be left to history.