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  • Writer's pictureOren Levin-Waldman

Mainstream Economics Too Often Ignores the Power Imbalance in Labor Markets

As the nation begins to emerge from the pandemic and the economy improves, it might behoove us to reflect on the so-called “natural” process of wage determination. According to the neoclassical model of competitive markets, a market clearing wage is achieved when the demand for labor is exactly equal to the supply of labor. Therefore, there is no such thing as unemployment because wages either rise or fall until the demand for labor is exactly equal to the supply.

At the wage at which demand equals supply, all those willing to work at that wage will be employed. If more people are willing to work, the wage will fall further, thereby inducing firms to hire more workers, with the result being that the supply of labor once again equals the demand. A wage floor, such as a mandated minimum wage, prevents the cost of labor from dropping below the minimum. What this has come to mean is that the worker has it in his/her power to accept lower wages in order not to be unemployed. And yet, this totally misses a power dynamic that most neoclassical economists choose to ignore.

The assumption is that employers and workers are equal in their ability to negotiate the employment contract, which includes wages, benefits, and working conditions. But in reality, they are not equals because there is an asymmetrical power imbalance between them. Whereas firms are wants traders, workers are needs traders. The needs trader is forced to accept a job at whatever wage is being offered in order to eat. Firms, and especially large ones, can postpone hiring workers until there is an available pool of workers willing to accept whatever wages are being offered.

Because of the power dynamic, workers’ only ability to bargain is to either accept or reject an employment offer. This effectively makes the employment contract somewhat exploitive. This is even more the case for low-skilled workers who have nothing to offer in exchange for higher wages. The neoclassical economist will basically defend the low-wages offered to the low-skilled worker on the grounds of the supply and demand curve. The more low-skilled workers are in the labor market, the lower the wages will be.

This too does not capture the reality of the labor market because there are multiple supply and demand curves for the multiple labor markets in which there are different levels of skill and/or educational attainment. That is, the more skills a worker has, the more a worker can demand higher wages. A shortage of skilled workers in a skilled labor market will push up wages in that market. Again, the worker has it in her/his power to command higher wages because s/he has the ability to obtain the requisite skills. Of course, this may overstate the case for those workers who are consigned to the low-wage and low skilled labor market because they lack natural endowments.

Still, employers enjoy market power and can push down wages in skilled labor markets simply by increasing their size and becoming labor monopsonies. A classic case is the nursing labor market whereby hospitals which have been absorbed into larger hospital corporations are in a position to exert downward pressure on their wages because they are the principal purchasers of nurses’ labor power.

The supreme irony in the neoclassical model is that many of its adherents who laud Adam Smith overlook what Smith had to say about the matter. Smith recognized that firms could and would collude with one another to suppress wages. Because of that he also understood why workers might be inclined to respond to that by forming unions to obtain a measure of bargaining power. In neither case would the marketplace be operating naturally. As much as unions would be artificially inflating wages, collusion among employers would be artificially suppressing wages.

Although there is nothing in the Wealth of Nations to suggest that Smith supported minimum wages, Smith is clear that the power of government should be used to break up monopolies because they prevent the marketplace from being fully competitive. For Smith, the invisible hand of competition would work to maintain a fair marketplace where all actors — producers, consumers, and workers alike — could prosper. It should be remembered that Smith was less an economist, and more a moral philosopher.

Clearly the same logic can be applied to the labor market. A monopoly threatens competitive markets because it can raise prices beyond goods’ natural worth, leaving consumers no choice but to pay those prices. A monopsony, however, threatens a workers’ ability to bargain over wages, even skilled workers, because as the principal purchaser of their labor services, it can exert downward pressure on wages below those workers’ worth. And again, workers, because they are needs traders, have no choice but to accept them.

It should be the goal of all economic policy seeking growth and greater prosperity to see wages for everybody rise. And yet, much of corporate profitability and increasing shareholder value rests on paying low wages through measures that control workers and break their wage rigidity. In the global marketplace, this has been easily accomplished through disinvestment and capital mobility. Workers are no doubt chastened when their jobs are relocated elsewhere.

Because there is a power dynamic that undermines the so-called natural process of wage determination, there are clearly ways to even the playing field and give workers a measure of market power. The most obvious are to strengthen labor market institutions like labor unions and minimum wages. In tandem with this, more pro-labor appointments should be made to the National Labor Relations Board (NLRB), as well as this should be a consideration when making future appointments to the Supreme Court.

Government could also enforce antitrust laws and break up monopolies. These laws have not been enforced because in many cases they have been beneficial to consumers in the form of lower prices. Consequently, courts have applied the public benefit standard. But they have not been good for workers because of the monopsonies they become. The impact on workers and wages should be as much a consideration as the impact on consumers.

Still, there may be another approach which nobody has really considered. Although the tax code should primarily be about raising revenue rather than social engineering, it could nonetheless be used to encourage employers to raise wages. Raising taxes on corporations and the wealthy to pay for new programs is most likely counterproductive because the wealthy can evade taxes and corporations can not only offshore, but pass it onto consumers through higher prices, But when inducements are offered in the form of lower taxes, those inducements can be offered on the condition of paying workers higher wages. There will be endless fights over corporate tax rates, but only those firms willing to pay higher wages to their workers should receive them. Otherwise, low-wage employers should continue to pay higher taxes.

It is high time that the political class that professes to care about working class people begin addressing the asymmetrical power imbalance in the labor market. There are tools available to assist workers and strengthen the middle class, which don’t require massive public spending and huge tax increases which will ultimately fall on the middle class.

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