Podcast
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Do Employers Have Too Much Power in Labor Markets?
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Chen Yeh discusses the differences in how much power companies have in labor markets and how that affects employees and their wages. Yeh is an economist at the Federal Reserve Bank of Richmond.
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Transcript
Tim Sablik: My guest today is Chen Yeh, an economist at the Richmond Fed. Chen, welcome back to the show.
Chen Yeh: Hi, Tim. Always good to be back. Thanks for having me.
Sablik: In your research, you explore differences among firms and what those differences mean for the broader economy. One kind of difference between firms is how much power a company can exercise in markets. Firms with market power have more control over the prices they set for their goods and services because they face less competition.
Firms can also exercise power over their inputs, such as labor. Businesses with this kind of influence are said to have monopsony power as opposed to monopoly power.
You recently co-authored a paper examining monopsony power in the U.S. manufacturing sector [also see Yeh's Economic Brief that summaries this paper]. Without getting too deep into the weeds, can you explain a little bit what monopsony power is and how economists think about it?
Yeh: The paper you're referring to was co-authored with Claudia Macaluso and Brad Hershbein, where we talk about monopsony or labor market power.
The way to think about monopsony is as the input analog of monopoly. Under a monopoly, there's usually only one seller of goods because consumers can only buy from one seller. That gives this seller market power. Monopsony is, as I said, the input analog. So, let's think about labor. There's only one buyer of inputs, so think about a region where there's only one employer. If there is only one employer that provides jobs, you can imagine that they have some kind of wage setting power. They can determine the wages of these workers.
When we measure monopsony power, the object of interest is something that we call the markdown. In simple terms, the markdown is a ratio of what a firm gains in terms of revenue and how much it costs.
Let me give you a concrete example: a worker, let's say a welder in a manufacturing plant. His services or her services add something to the product of the manufacturer, in this case the car. Let's say one hours' worth of work for this welder adds $20 in terms of revenues to the manufacturer. That's what the employer gains from adding one hour of this worker's time. The markdown is measuring that as a numerator, and then the denominator is basically the wage — what you pay this worker.
Under perfect competition, this ratio or this markdown is equal to one. That's fairly intuitive, right? If you as a worker don't get paid what you add to the firm and let's say markets are perfectly competitive, you can easily step away and leave for another firm. You can threaten the firm and say, "I'll go to someone else." That's why under perfect competition, an employer cannot simply cut wages below a worker's marginal product, what they bring to the firm. These workers can simply leave the firm and go to someone else, right? In this case, cutting wages would have a very big consequence on the quantity of labor.
Under monopsony, when there's labor market power, an employer can pay this worker less than what it brings to the firm. I could cut your wages below that $20 because you find it difficult to move to another employer.
Sablik: What happens when an employer has monopsony power and how do you go about measuring that?
Yeh: This is traditionally very hard to measure. The reaction of employment in terms of how much your wages get cut gives you an idea of how much wage setting power you have. If you cut, let's say, wages by a little bit and all your employees leave, you have no market power.
So, traditionally, the way we would measure market power is to see how steep that labor supply curve is — the relationship between wages and employment. Well, the problem is that's very difficult because wages and employment move simultaneously. It's very hard to separate labor demand and labor supply factors.
In our paper, we look at the firm side. We're saying, let's see how much one employee adds in terms of output or revenues to a firm and let's compare that to how much it costs. If there's a wedge between how much a worker brings and how much it costs, that must be profits. That's something for market power and that's how we measure monopsony.
Sablik: I imagine it's quite difficult to get this kind of data. How did you get this data and what data did you use?
Yeh: We used confidential micro-level data from U.S. Census Bureau. We focused, in particular, on the manufacturing sector.
The reason why we focused on manufacturing is because what a worker brings to a manufacturing plant's output or revenues also depends on other inputs. How much a welder can contribute to a car depends on the equipment that [he or she] has. It depends on the level of capital, input materials and energy, for that matter. The only sector where we have all that comprehensive data is in manufacturing.
Sablik: When you did your study, what evidence of monopsony power did you find in the manufacturing sector?
Yeh: In the end, we found that monopsony is quite widespread in U.S. manufacturing. There is obviously a large amount of variation across different industries.
Let me just give you a number for the average. Remember, under perfect competition, what you bring to the firm as a worker, that's what you should get paid in terms of your wage. What we found, though, is that for every dollar that a worker contributes to its employer revenues, this worker actually only keeps 65 cents on that dollar. In that sense, around a third of that dollar stays, to put a bluntly, in the pocket of the employer.
As I said, there's a lot of variation. For example, under textiles it's 79 cents on the dollar, whereas a chemicals worker only keeps 55 cents on the dollar. What we've found to be quite surprising is that, yes, there's a lot of variation. Some industries are subject to more monopsony than others. But none of them seem really close to the perfectly competitive benchmark, which used to be the standard in macroeconomic modeling.
Sablik: Have other researchers studied this as well and what have they found?
Yeh: The number of studies to bring up in this podcast is too long to mention. A useful source to talk about today is what we call a meta-study by Sokolova and Sorensen. It's a study that studies other studies. They looked at 50 papers and they collected 1,300 estimates on wage setting power. Our estimates are the median of these other studies.
Sablik: Did you also look at how monopsony power has changed over time in the U.S.?
Yeh: We did. We found that monopsony power declined between the late '70s and the early 2000s, but then from 2002 onward it rose sharply afterward.
The FTC held hearings in 2018 investigating the hypothesis of whether labor market power or monopsony could be behind this big decline in U.S. labor share. They were trying to figure out whether a big fraction of income is no longer going to workers. Is that due to labor market power or not? What our results seem to indicate is that that seems to be less likely because this decline in U.S. labor share already started from '77 to 2002 and only afterwards sharply rose.
I will say there is a caveat in the sense [of] how we define our aggregate measure of monopsony power. There are several ways to do it and I would say there's no consensus on what is the right way.
Sablik: How have policymakers responded to this evidence of monopsony?
Yeh: I wish I could say that it was my study that induced policymakers to take action, but that's unfortunately not true.
Antitrust authorities like the Department of Justice and Federal Trade Commission have recently updated their merger guidelines and put a lot of focus on the impact of mergers on labor markets. Typically, when two companies come together, we're worried about pricing — if goods become too expensive — and what's the harm for consumers. Implicitly, the DOJ and the FTC, in their mandate, they should protect not only consumers but also workers. The thing is, in the past, this was never explicitly mentioned. So, that's one aspect that's getting a lot of attention and where a lot of research is being done now.
We also saw it in the most recent Economic Report of the President by the Council of Economic Advisors. They talk about the labor market and unemployment [and] explicitly take this notion of, okay, what's the role of labor market power or monopsony? In that sense, I do think that this wave of studies that we saw around the beginning of the 2020s has induced a big policy response.
Sablik: Based on your research, in particular, are there particular types of policy responses or areas that you would recommend policymakers focus on?
Yeh: There are several aspects. Some of them are actually already in the works.
From an academic point of view, one very obvious direction to look at — it might surprise you — is the minimum wage. There's always been a big debate on the effects of the minimum wage. Of course, when we increase wages that's good for workers. But then the counterpart argument is always employers don't like higher wages, so if they have to pay more, then to save on costs they have to cut employment. The argument would always be, well, a rise in minimum wages could be bad because it could reduce employment.
What's interesting is that under monopsony, when the minimum wage increases employment can actually rise. The way to think about it is as follows. If you have monopsony power as a firm, when you decide on how many workers to hire, you know that you will impact the wage. If I want to hire more workers, I have to pay them more and I control by how much that wage can go up. So, what happens under the minimum wage, if you cannot pay workers less than $15 an hour? You might have had some ideas as a firm of how many workers to hire if they would get paid less than $15 an hour, and then you would have had an incentive to suppress employment. But now [under monopsony], if there's a regulation that says there's a minimum wage, you cannot pay less than $15 an hour, you're not giving firms that opportunity anymore. In that case, they just start pricing according to that amount, and then they will hire maybe a larger amount than they were originally thinking of because those employment suppressing incentives are eliminated.
Another like area that we can think about that would be implied from the paper is how to think about these industry giants. In our research, we found that large firms have more labor market power. Those employers that command a larger fraction of employment that's in a given labor market have higher markdowns. This might create some scope for regulating very large firms. There might be some scope for cutting them up or not thinking about mergers between two large entities.
Sablik: Are you planning to explore any other questions in this space?
Yeh: I'm currently working on a paper that gauges the magnitude of what we call labor market collusion. In the previously mentioned paper on monopsony, we quantify a lot of labor market power, but we really don't say much about what's causing labor market power. In this paper that's in the works, we talk about a potential source of that being collusion.
Think about an area that has employers at fast food chains. What these employers can do is they can come together — which is illegal, but it may happen — and they can say let's decide to not pay cooks more than a certain amount per hour. If you happen to be a cook, you don't have a choice but to accept this lower wage. So, this is what I mean by collusion. In this project that I'm working on, I'm trying to quantify that — let's investigate how much of that is going on in the U.S. economy and to what extent that is causing monopsony.
Sablik: Well, Chen, thanks very much for coming on the show today to talk about your work studying monopsonies.
Yeh: Thank you so much. Always a pleasure.
