oligopsony

Wage-matching and the collusion under our noses

PNRJ critique of neoclassical economics, inequality, public policy , , , , , , , , ,

Jul 20 JDN 2460877

It was a minor epiphany for me when I learned, over the course of studying economics, that price-matching policies, while they seem like they benefit consumers, actually are a brilliant strategy for maintaining tacit collusion.

Consider a (Bertrand) market, with some small number n of firms in it.

Each firm announces a price, and then customers buy from whichever firm charges the lowest price. Firms can produce as much as they need to in order to meet this demand. (This makes the most sense for a service industry rather than as literal manufactured goods.)

In Nash equilibrium, all firms will charge the same price, because anyone who charged more would sell nothing. But what will that price be?

In the absence of price-matching, it will be just above the marginal cost of the service. Otherwise, it would be advantageous to undercut all the other firms by charging slightly less, and you could still make a profit. So the equilibrium price is basically the same as it would be in a perfectly-competitive market.

But now consider what happens if the firms can announce a price-matching policy.

If you were already planning on buying from firm 1 at price P1, and firm 2 announces that you can buy from them at some lower price P2, then you still have no reason to switch to firm 2, because you can still get price P2 from firm 1 as long as you show them the ad from the other firm. Under the very reasonable assumption that switching firms carries some cost (if nothing else, the effort of driving to a different store), people won’t switch—which means that any undercut strategy will fail.

Now, firms don’t need to set such low prices! They can set a much higher price, confident that if any other firm tries to undercut them, it won’t actually work—and thus, no one will try to undercut them. The new Nash equilibrium is now for the firms to charge the monopoly price.

In the real world, it’s a bit more complicated than that; for various reasons they may not actually be able to sustain collusion at the monopoly price. But there is considerable evidence that price-matching schemes do allow firms to charge a higher price than they would in perfect competition. (Though the literature is not completely unanimous; there are a few who argue that price-matching doesn’t actually facilitate collusion—but they are a distinct minority.)

Thus, a policy that on its face seems like it’s helping consumers by giving them lower prices actually ends up hurting them by giving them higher prices.

Now I want to turn things around and consider the labor market.

What would price-matching look like in the labor market?

It would mean that whenever you are offered a higher wage at a different firm, you can point this out to the firm you are currently working at, and they will offer you a raise to that new wage, to keep you from leaving.

That sounds like a thing that happens a lot.

Indeed, pretty much the best way to get a raise, almost anywhere you may happen to work, is to show your employer that you have a better offer elsewhere. It’s not the only way to get a raise, and it doesn’t always work—but it’s by far the most reliable way, because it usually works.

This for me was another minor epiphany:

The entire labor market is full of tacit collusion.

The very fact that firms can afford to give you a raise when you have an offer elsewhere basically proves that they weren’t previously paying you all that you were worth. If they had actually been paying you your value of marginal product as they should in a competitive labor market, then when you showed them a better offer, they would say: “Sorry, I can’t afford to pay you any more; good luck in your new job!”

This is not a monopoly price but a monopsonyprice (or at least something closer to it); people are being systematically underpaid so that their employers can make higher profits.

And since the phenomenon of wage-matching is so ubiquitous, it looks like this is happening just about everywhere.

This simple model doesn’t tell us how much higher wages would be in perfect competition. It could be a small difference, or a large one. (It likely varies by industry, in fact.) But the simple fact that nearly every employer engages in wage-matching implies that nearly every employer is in fact colluding on the labor market.

This also helps explain another phenomenon that has sometimes puzzled economists: Why doesn’t raising the minimum wage increase unemployment? Well, it absolutely wouldn’t, if all the firms paying minimum wage are colluding in the labor market! And we already knew that most labor markets were shockingly concentrated.

What should be done about this?

Now there we have a thornier problem.

I actually think we could implement a law against price-matching on product and service markets relatively easily, since these are generally applied to advertised prices.

But a law against wage-matching would be quite tricky indeed. Wages are generally not advertised—a problem unto itself—and we certainly don’t want to ban raises in general.

Maybe what we should actually do is something like this: Offer a cash bonus (refundable tax credit?) to anyone who changes jobs in order to get a higher wage. Make this bonus large enough to offset the costs of switching jobs—which are clearly substantial. Then, the “undercut” (“overcut”?) strategy will become more effective; employers will have an easier time poaching workers from each other, and a harder time sustaining collusive wages.

Businesses would of course hate this policy, and lobby heavily against it. This is precisely the reaction we should expect if they are relying upon collusion to sustain their profits.

Are unions collusion?

PNRJ critique of neoclassical economics, ethics, market failure, public policy , , , , , , , , , , ,

Oct 31 JDN 2459519

The standard argument from center-right economists against labor unions is that they are a form of collusion: Producers are coordinating and intentionally holding back from what would be in their individual self-interest in order to gain a collective advantage. And this is basically true: In the broadest sense of the term, labor unions are are form of collusion. Since collusion is generally regarded as bad, therefore (this argument goes), unions are bad.

What this argument misses out on is why collusion is generally regarded as bad. The typical case for collusion is between large corporations, each of which already controls a large share of the market—collusion then allows them to act as if they control an even larger share, potentially even acting as a monopoly.

Labor unions are not like this. Literally no individual laborer controls a large segment of the market. (Some very specialized laborers, like professional athletes, or, say, economists, might control a not completely trivial segment of their particular job market—but we’re still talking something like 1% at most. Even Tiger Woods or Paul Krugman is not literally irreplaceable.) Moreover, even the largest unions can rarely achieve anything like a monopoly over a particular labor market.

Thus whereas typical collusion involves going from a large market share to an even larger—often even dominant—market share, labor unions involve going from a tiny market share to a moderate—and usually not dominant—market share.

But that, by itself, wouldn’t be enough to justify unions. While small family businesses banding together in collusion is surely less harmful than large corporations doing the same, it would probably still be a bad thing, insofar as it would raise prices and reduce the quantity or quality of products sold. It would just be less bad.

Yet unions differ from even this milder collusion in another important respect: They do not exist to increase bargaining power versus consumers. They exist to increase bargaining power versus corporations.

And corporations, it turns out, already have a great deal of bargaining power. While a labor union acts as something like a monopoly (or at least oligopoly), corporations act like the opposite: oligopsony or even monopsony.

While monopoly or monopsony on its own is highly unfair and inefficient, the combination of the two—bilateral monopoly—is actually relatively fair and efficient. Bilateral monopoly is probably not as good as a truly competitive market, but it is definitely better than either a monopoly or monopsony alone. Whereas a monopoly has too much bargaining power for the seller (resulting in prices that are too high), and a monopsony has too much bargaining power for the buyer (resulting in prices that are too low), a bilateral monopoly has relatively balanced bargaining power, and thus gets an outcome that’s not too much different from fair competition in a free market.

Thus, unions really exist as a correction mechanism for the excessive bargaining power of corporations. Most unions are between workers in large industries who work for a relatively small number of employers, such as miners, truckers, and factory workers. (Teachers are also an interesting example, because they work for the government, which effectively has a monopsony on public education services.) In isolation they may seem inefficient; but in context they really exist to compensate for other, worse inefficiencies.


We could imagine a world where this was not so: Say there is a market with many independent buyers who are unwilling or unable to reliably collude, and they are served by a small number of powerful unions that use their bargaining power to raise prices and reduce output.


We have some markets that already look a bit like that: Consider the licensing systems for doctors and lawyers. These are basically guilds, which are collusive in the same way as labor unions.

Note that unlike, say, miners, truckers, or factory workers, doctors and lawyers are not a large segment of the population; they are bargaining against consumers just as much as corporations; and they are extremely well-paid and very likely undersupplied. (Doctors are definitely undersupplied; with lawyers it’s a bit more complicated, but given how often corporations get away with terrible things and don’t get sued for it, I think it’s fair to say that in the current system, lawyers are undersupplied.) So I think it is fair to be concerned that the guild systems for doctors and lawyers are too powerful. We want some system for certifying the quality of doctors and lawyers, but the existing standards are so demanding that they result in a shortage of much-needed labor.

One way to tell that unions aren’t inefficient is to look at how unionization relates to unemployment. If unions were acting as a harmful monopoly on labor, unemployment should be higher in places with greater unionization rates. The empirical data suggests that if there is any such effect, it’s a small one. There are far more important determinants of unemployment than unionization. (Wages, on the other hand, show a strong positive link with unionization.) Much like the standard prediction that raising minimum wage would reduce employment, the prediction that unions raise unemployment has largely not been borne out by the data. And for much the same reason: We had ignored the bargaining power of employers, which minimum wage and unions both reduce.

Thus, the justifiability of unions isn’t something that we could infer a priori without looking at the actual structure of the labor market. Unions aren’t always or inherently good—but they are usually good in the system as it stands. (Actually there’s one particular class of unions that do not seem to be good, and that’s police unions: But this is a topic for another time.)

My ultimate conclusion? Yes, unions are a form of collusion. But to infer from that they must be bad is to commit a Noncentral Fallacy. Unions are the good kind of collusion.