Why We Should Worry About Monopsony

By David Weil, Dean and Professor, Heller School of Social Policy and Management at Brandeis University. Originally published at the Institute for New Economic Thinking website

When a small group of companies can dominate a labor market, wages – and workers – suffer

Center stage in the meeting of the Federal Research Bank of Kansas City’s annual symposium in Jackson, Wyoming this August was a discussion of the repercussions of having a small number of companies dominating the labor markets where they hire workers–what economists call “monopsony.” on an annual meeting that the financial, business, and economics professions watch closely marks the clear arrival of the topic into the mainstream of economic dialogue. Along with debating the overall impacts of growing market control of companies like Amazon and Google, participants discussed what role monopsony plays in explaining the absence of significant wage growth in the presence of historically low unemployment rates and how the Federal Reserve should factor its effects into upcoming monetary policy decisions.

What accounts for the sudden appearance of monopsony on the august (and August) agenda of the Federal Reserve? Should we be concerned about monopsony because of the puzzles it potentially creates about the true natural rate of unemployment and its impact on monetary policy? Is it its allocative efficiency impacts on markets and resulting social losses in the labor market?

Although monopsony has implications for the above questions, I will argue here its importance primarily arises in how it affects the way that wages are determined and its consequent impact on earnings inequality. That is because concentration of economic power in product and labor markets has led to changes in how businesses structure themselves, particularly with respect to employment.

From Monopoly to Monopsony

The ascendancy of Amazon as a major and transformative force in retailing has reawakened public concern in a very old issue—economic concentration. The economics profession and public policy discussions stemming from it weigh market power from two opposing perspectives. On one hand, companies can come to dominate their sectors through superior product offerings, innovations in production that confer technological or cost advantages, or through capitalizing on a combination of those traits that create scale economies that provide further costs advantages over rivals. These are all net positives for society in that they deliver better products or services at lower costs.

On the other hand, market dominance can lead firms to use raise price and restrict output. A powerful company that maintains prices that are above those that would prevail in more competitive markets deprives access of goods to consumers who would pay a price above the cost of production (including a normal rate of return) but below the company’s price. That means a loss for overall societal wellbeing since the additional benefits to society from consumption of goods foreclosed by the monopolist outweighs the additional costs of providing those goods to society. Market power is also a problem for economists when used to keep other competitors from entering the market, further strengthening the incumbents’ economic position and market power.

Although first recognized by , economists have recently turned attention to the parallel issue of monopsony—conditions where a single buyer dominates a market, in particular cases where a company or small number of companies dominate their labor market. By exercising power in the labor market, companies are able to set wages below those that would prevail in the more competitive conditions posited in economic models. Rather than being forced to equate their economic gains of adding hours and workers against the preferences of workers in the labor market, monopsonists exercise their dominant position by paying below the wage rates that would prevail in a competitive This hurts society in that additional workers who would otherwise come into the labor market decide cannot do so, even though there are opportunities to provide additional employment and still produce products profitably.

Monopsony Goes Mainstream

For decades after Robinson first explored its potential impacts in the depression-era labor markets of the US and Europe of the 1930s, monopsony was usually invoked in graduate labor economics seminars in regard to coal mining “company towns.” But it began to gain greater attention in the 1990s in the profession as empirical studies of minimum wages on employments ran into an unexpected finding (pioneered by and then replicated in a growing body of studies): increases in state-level minimum wages resulted in very small impacts on employment. That empirical result is inconsistent with a world of competitive labor markets, where price floors like the minimum wage if set above the competitive wage rate drive wedges between supply and demand of labor leading companies to lay off now more expensive workers. If monopsony conditions prevail, on the other hand, minimum wage policies may compel companies to hire additional workers at the higher rate (and still do so profitably).

In the closing days of the Obama administration, the drew even greater attention as a partial explanation for the absence of significant wage growth despite the longest economic expansion in history. Growing product market concentration and the rise of Superstar firms with significant economic power in their labor markets could potentially explain the absence of wage growth (as well as the falling share of national income going to labor). Growing evidence on the prevalence of market power and new evidence on drivers of increases in earning inequality in just the last three years have brought monopsony into the mainstream, further bolstered by the continuing for most working Americans, despite the continuing recovery.

How Do Firms Use Monopsony Power?

The discussion of monopsony focuses on its impact on median wage setting. It tends to abstract the nature of wage determination as economic models often do. This obscures an important link to what I believe to be a profound effect of monopsony power. It allows companies who hold it to change the way they set wages. Monopsony potentially confers an ability to solve an old problem for companies—balancing paying wages linked to performance against internal equity norms that, if ignored, have morale and performance consequences of their own. Market power confers an ability for companies to change the very structure of their internal labor markets to allow them to not only reduce wages for median workers, but to change the structure of pay entirely. They can do so through what I have long been arguing is a central transformation in the economy: the fissured workplace.

Reviewing another strategy pursued by businesses in concentrated markets makes the connection between monopsony and the fissured workplace clearer. Companies that dominate their product market use that economic power to alter the way they set prices through price discrimination. Although it sounds nefarious, price discrimination in most cases is legal and simply describes a company charging different prices for the same good or service to different purchasers according to their willingness to pay. It is ubiquitous: one need simply reflect on the range of prices charged for similar services such as air travel, entertainment, hotel rooms, access to internet services, or package delivery. Companies with market power—and you need market power to maintain multiple prices for the same product—increase their profitability by matching consumers’ willingness to pay to the prices they set for them. In economic terms, facing products or services with a similar marginal cost, charge a higher mark up to consumers with more inelastic preferences than those with greater price sensitivity.

Why wouldn’t a monopsonist want do the same? Why not wagediscriminate, thereby paying workers closer to the marginal cost of enticing them to do work, thereby extracting more of the benefits of their work to the bottom line of companies? Why not indeed?

Fissured Work and Wage Discrimination

Every day, we eat at restaurants, stay at hotels, receive packages, and use our digital devices with the assumption that the branded company we pay for these services — Amazon, Apple, Marriott, etc. – also employs the people who deliver them. This assumption is increasingly incorrect: Our deliveries are often made by contractors and our hotel rooms are cleaned by temporary employees from staffing agencies. This is what I deemed the , the cracks upon which today’s economy largely rest, and it leaves so many without fair and decent wages, a career path, and a safe work environment. And while it’s true that low wage workers have been hard hit by the consequences of fissuring for some time, those with college and graduate educations, even in professions once regarded as protected from the ups and downs of churning labor markets, are being affected as well.

Over the past few decades, major companies throughout the economy have faced intense pressure to improve financial performance for private and public investors. They responded by focusing their businesses on – that is, activities that provide the greatest value to their consumers and investors – and by shedding less essential activities. The companies that often dominate their sectors emerged as more focused and highly profitable players in their markets (the superstar firms referenced above that some argue dominate and change their industries).

Firms typically started outsourcing activities like payroll, publications, accounting, and human resources. But over time, this spread to activities like janitorial and facilities maintenance and security. Still in many cases it went deeper, spreading into employment activities that could be regarded as core to the company: housekeeping in hotels; cooking in restaurants; loading and unloading in retail distribution centers; even basic legal research in law firms.

Like a fissure in a once solid rock that deepens and spreads, once a business sheds an activity like janitorial services or housekeeping, the secondary businesses doing that work is also affected, often shifting those activities to still other businesses. A common practice in janitorial work, for instance, is for companies in the hotel or grocery industries to outsource that work to cleaning companies. Those companies, in turn, often hire smaller businesses to provide workers for specific facilities or shifts. Because each level of a fissured workplace structure requires a financial return for their work, the further down one goes, the slimmer are the remaining profit margins. At the same time, as you move downward, labor typically represents a larger share of overall costs — and one of the only costs in direct control for satellite players further from the superstar firm around which they orbit.

Seen in the context of wage setting, the fissured workplace offers a company a mechanism to implement wage discrimination. This affords it an opportunity to reduce compensation costs—as well as exposure to liability for a wide variety of workplace policies—in a far more comprehensive manner than many of the accounts of monopsony acknowledge.

Wage Determination in a Fissured Workplace

In the late 1800s, commented on the need to set unified wages in a workplace in order to maintain civility. “The most autocratic and unfettered employer spontaneously adopts Standard Rates for classes of workmen, just as the large shopkeeper fixes his prices, not according to the haggling capacity of particular customers, but by a definite percentage on cost (p.281).” Large employers that dominated the economy in the post-World War II era drew on unified personnel and pay policies and internal labor markets for a variety of reasons: to take advantage of administrative efficiencies, to create consistency in corporate policies, and to reduce exposure to violations of laws. They did so through collective bargaining with unions that codified these arrangements in the . But large businesses also adopted similar wage and salary setting practices in .

Fairness norms and considerations influence wage setting within an organization. A large empirical literature from psychology, decision science, and more recently behavioral economics reveals that people care not only about their own gains but also about those of others. In fact, people frequently gauge the magnitude of their own benefits relative to those of others. And they are often willing to sacrifice some of their own gains because of equally important beliefs about fairness in . Deference to fairness norms helps explain why large companies often adopted compensation policies that varied little in terms of productivity for jobs of a similar title or occupation (deferring to horizontal equity norms). Fairness considerations also led those companies to peg compensation increases for moving up in an organization on (vertical equity norms).

However, the fissured workplace changes that calculus. By shedding their own employees in a variety of ways and making those workers the employees of other organizations, a wage setting problem becomes a standard pricing problem. The janitor, maintenance person—or even lawyer—who no longer is a member of the company also no longer needs be bounded by the pay considerations of that company’s wage structure.

Vignette: Wage Setting in High Technology, 1980 and 2017

This impact of the fissured workplace is illustrated by a story reported by of the New York Times. Irwin charts the history of two women, both employed as janitors at cutting-edge technology companies, but at two different moments in time. Gail Evans worked as a janitor for Kodak in the early 1980s. Like most janitors of that era, Evans worked as an employee of that large, thriving, non-union company. As such, when her film plant closed, Kodak reassigned her to another facility. As an employee who earned above average wages and benefits relative to workers in smaller companies, she also had access to training benefits. She used those benefits to take courses in the evening on information technology, learning how to build spreadsheets in the early years of that software. As Irwin writes:

A manager learned that Ms. Evans was taking computer classes while she was working as a janitor and asked her to teach some other employees how to use spreadsheet software to track inventory. When she eventually finished her college degree in 1987, she was promoted to a professional-track job in information technology. Less than a decade later, Ms. Evans was chief technology officer of the whole company, and she has had a long career since as a senior executive at other top companies.

In contrast, Irwin writes about Marta Ramos, who in 2017 worked as a janitor for Apple. Like many janitors in the fissured workplace, Ramos was employed at the time as a contractor to the company. She was fortunate to be represented by a union (uncommon for most contract janitors) and therefore earned an above average wage—$16.60—relative to the median average hourly earnings for janitors of about $12.00, and also had access to health and retirement benefits. But unlike Gail Evans, Marta Ramos was not part of Apple and could lay no claim to upward mobility out of the ranks of being a janitor and into that company’s job structure. Her future mobility resided in the contract company for who she worked.

When you are no longer “our janitor,” your pay ceases to be bound by that of others in a similar or even unrelated part of the same company. As a result, considerable divergences grow between the current and prospective wages of people who do the same kind of work if that work is contracted out—the trajectories of a Gail Evans versus Marta Ramos.

Fissured Mechanisms for Wage Discrimination

When you work as an employee for a major business, decades of research demonstrate that wages tend to get a bounce, regardless of whether that large employer is a union shop or not. by experimental economists demonstrate the importance of fairness considerations in pay practices within the “walls” of companies. But if you are a subcontractor or an employee of a staffing agency, you are no longer a part of the corporate family. When firms set wages for their employees, the wages of the janitor or administrative assistant tends to be carried up by that of higher paid workers because of fairness norms. In short, fissuring employment changes the wage-setting relationship into a price-based market transaction between the lead business and a provider of service to it, whether a subcontractor, franchisee, or staffing agency. That means the price for the service can be tailored to the lead firm’s willingness to pay, with the pay to the workers doing that work substantially below what it would have been if directly employed.

By shifting employment to subordinate organizations external to the enterprise that operate in competitive markets, the lead firm creates a mechanism whereby workers will receive a wage close to the additional value they create. At the same time, this avoids the problem of having workers with very different wages operating under one roof. As a result, two workers on the same project may effectively end up being paid very different wages, closer to something reflecting their individual marginal productivity than would be the case if they were in the direct employ of the parent organization.

Because each level of a fissured workplace structure requires a financial return for their work, the further down one goes, the slimmer are the remaining profit margins. At the same time, as you move downward, labor typically represents a larger share of overall costs — and one of the only costs in direct control for satellite players further from the mothership, so to speak. That means the incentives to cut corners rise — leading to violations of our fundamental labor standards.

Evidence for Wage Discrimination and the Fissured Hypothesis

Using fissured work to wage discriminate would predict that the earnings of workers undertaking the same work inside of companies have lower earnings when that work shifts to contractors / firms outside of those companies. Empirical evidence on specific occupations that are shifted from “inside” to “outside” of a business confirm this prediction.

Janitors and security guards were in the vanguard of fissuring. By 2000 about 45% of janitors worked under contracting arrangements, and more than 70% of guards were employed as . As predicted by the above logic, shifting janitors and security guards from inside to outside the walls of lead businesses has indeed significantly impacted pay for . found that janitors who worked as contractors earned 15% less than those working in-house, and contracted security guards earned 17% less than comparable in-house guards. Similarly, estimated a “wage penalty” for working as a contractor of 4%–7% for janitors and 8%–24% for security guards.

provide similarly compelling evidence of changing wage structures in Germany. They show significant growth in domestic service outsourcing of a variety of activities beginning in the 1990s. Using a carefully constructed sample allowing them to compare wages of food service, cleaning, security, and logistic workers, they examine the impact of moving the same jobs from “inside” to “outside” businesses engaged in domestic outsourcing. Their results show reductions in wages ranging from 10-15% of those jobs outsourced relative to those that were not.

historically received an extra bump in their earnings (“large firm earnings premium”) by being in large companies—somewhere between 8-12% above what comparable workers at smaller, but otherwise similar companies earned.  For neo-classic models, the persistence of this bump in earnings—unexplained by differences in either labor supply or the productivity of firms employing these workers—was a puzzle. The prior discussion, beginning with the Webbs’ prescient comment in the late 1800s, explains the persistence of the large firm earnings bump. But it also would suggest that the fissured workplace would act in the opposite direction, eroding that differential.

Recent evidence by confirms that prediction: the large firm wage premium has eroded substantially in recent years. This reduction is due to the dramatic decline of wage premiums at very large firms (those with 1,000–2,500 employees), a decline not readily explained by differences in the quality or composition of the workforce or by the cross section of companies in the largest firm grouping. Very large firms also appear to shift their hiring towards high wage workers over time, a tell-tale sign of shedding lower-end workers through a fissured workplace strategy.

document the association between rising product market concentration in a wide variety of industries and the corresponding reduction in the labor share of income in them. At one level, industry concentration and the increasing profitability of a smaller number of superstars leads mechanically to a reduction of the labor share in firm-value added. But the rise of those superstar firms in the first place—presumably attributable to their dominance in core competency in an area of their business as illustrated in a variety of examples above—and their restructuring of their organization to shift work out to other parties in more competitive parts of their own sector or to other allied industries (e.g. business services) would provide a mechanism that drives those shifts and further exacerbates them. Along with the finding of Bloom et.al.that the declining large firm earnings premium is in part driven by the shedding of lower level jobs by large firms and the reduction of premiums particularly for the remaining jobs at the low-end of earnings distributions, this evidence is compatible with a fissured workplace explanation for the declining labor share story.

In sum, recent studies on earnings inequality offer compelling evidence consistent with the fissured workplace hypothesis. The fissured workplace has led to a separation of activities between lead businesses and subordinate networks of other enterprises who support them. This has enabled superstar firms with monopsony power have found a mechanism to solve the pay problem suggested by the Webbs.

Why Monopsony Matters

Companies that price discriminate find ways to translate their market power and the unwillingness (or inability in the case of monopoly) of customers to walk away in the face of higher prices into economic profits. The real consequence of price discrimination is the transfer of “consumer sur” (the additional benefit a consumer obtains from the purchase of a good or service beyond the price paid for it) to economic profit.

So too wage discrimination. Along with monopsony power leading to lower median wages, wage discrimination transfers more and more of the value-added by workers to the owners of capital for whom they work. The consequence of monopsony is fundamentally a distributional one that contributes to the rise in earnings inequality. And, given the decline of unions, the diminishment of workers’ ability to pursue claims in through public policies because of mandatory arbitration agreements and class action, and the erosion of norms of the large workplace, the losses to workers have been .

Connecting monopsony power and overall economic concentration to the fissured workplace provides a more comprehensive account of the consequences of growing market power. Much of the current policy discussion about monopsony focuses on the use of non-compete agreements and other arrangements that allow firms to collude on lower wages than would prevail under more competitive conditions. The wage discrimination implications of monopsony are potentially more pervasive and may occur at lower levels of industry concentration than might be required by full-blown collusion.

Even more, it suggests that the most pressing problem posed by monopsony is not one of allocative efficiency or its impacts on monetary policy. It is its impact on equity and fairness. . As we celebrate another Labor Day marked by continued decline of unions and the erosion of bargaining leverage of all workers, discussions of public policy approaches to monopsony should link to broader debates about responses to ever-growing concentration of wealth and income and the continuing erosion of the bargaining position of the majority of working people. As monopsony enters into the wider political discourse, making these connections clear could not be more important or timely.

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