The Economic Argument For the Minimum Wage

“If all economists were laid end-to-end, they would not reach a conclusion.”—George Bernard Shaw

We economists are notorious for our disagreements. There are liberal economists. There are conservative economists. And then there are economists like me in the middle. Yet when it comes to the minimum wage, most economists are in agreement—raising the minimum wage reduces employment opportunities for those minimum wage workers.

Of course in any profession there are always those who disagree with the conventional wisdom. It is no different with economists and the minimum wage. In the 1990’s, two well-regarded economists, David Card and Alan Krueger, authored a book in which they argued that small minimum wage increases generate no employment reductions.

They justified their views by claiming that labor markets suffer from a problem known as monopsony power. (If you are like my students your eyebrows just furrowed while you wondered if “monopsony” is a real word). This monopsony power is really just the opposite of monopoly power. For example, OG&E (like most electric utilities) has monopoly power—relatively few competitors selling electricity to the same market. Since OG&E faces relatively little competition from other sellers, it is able to charge inefficiently high prices for their service. As a result, economists admit that government can intervene and force OG&E to charge a more-efficient, lower price. This is why the Oklahoma Corporation Commission regulates the prices that OG&E charges their customers.

With monopsony power, though, it is the buyers and not the sellers that face relatively little competition. In this case, the buyers face little competition from other buyers wanting to buy the same item. This allows buyers to pay inefficiently low prices. As with the case of monopoly power, economists recognize that with monopsony power there is a potential role for government. In this case, the government can intervene to force buyers to pay a more-efficient, higher price. In labor markets this higher price is the minimum wage.

Economists have long accepted the monopsony power argument for policies like the minimum wage, and we know that many labor markets suffer from monopsony power problems. For example, the market for Major League Baseball players suffered from monopsony power prior the onset of free-agency in the mid-1970’s. Until that time, players were only allowed to negotiate future contracts with the team for which they most recently played. Thus, there was only one team that was able to buy their labor. These teams did not have to worry about other teams luring players away with larger salaries. With the onset of free-agency, however, players were free to negotiate with all of the teams. This additional competition among the buyers of baseball labor has led to a dramatic increase in baseball salaries.

However, most economists simply do not agree with the argument that the market for minimum wage labor suffers from this same monopsony power problem. Notice that for monopsony power to exist, there needs to be a lack of competition among the buyers of minimum wage labor. However, there are clearly many firms that hire minimum wage workers (retail shops, hotels, fast-food restaurants, etc.). As a result, if one firm tries to pay less than the market wage rate they will have difficulty attracting the employees they need. In other words, these firms face competition from other firms wanting to hire the same labor. Consequently, these firms do not have monopsony power.

In the absence of monopsony power economists—even Card and Krueger—agree that minimum wage laws reduce employment opportunities for the very workers they are trying to help. While economists like to disagree on many issues, the effects of the minimum wage is not one of them.

Feel free to submit your comments to mhepner@ucok.edu.

Restraining competition in air services: Government’s role

International airlines need the permission of at least two governments: those at the points of departure and arrival. Many governments tightly control airline capacity, frequency, and fares through bilateral aviation agreements. Owing to these controls, an airline that cuts fares might not get government permission to expand its flights to meet the increase in quantity demanded. Hence, government regulation inhibits airlines from cutting fares. In addition, regulation also limits the entry of new airlines.

For instance, under its air services agreement with India, the Australian Government may designate up to two airlines that may provide up to 2,100 seats per week of service to India. In early 2004, Qantas applied for designation to provide all 2,100 seats. At that time, there were no direct air services between Australia and India. All passenger traffic, totaling over 231,000 in the year 2003-04, passed through intermediate points such as Bankok and Singapore.

Low-cost carrier, Backpackers Xpress, challenged Qantas for the designation. Backpackers Xpress contended that its entry would “promote fairer pricing, better services and overall efficiency.” After deliberating submissions by both airlines and other parties, Australia’s International Air Services Commission decided that Backpackers Xpress was not ready to commence service, and designated Qantas to provide all 2,100 seats per week.

Source: Australian Government, International Air Services Commission, Determination, 2004 IASC 104.

Taxi Service in Washington DC Dulles airport

Washington Flyer is the only taxi company which is allowed to pick up riders at Dulles airport. As some visitors point out, “this is a strange welcome to the capital of the free – market world.” At a time when the president and governmental institutions are advocating gas conservation, it is particularly amusing to see taxis from other companies leaving empty (other companies are allowed to drop off passengers at the airport, but they are not allowed to pick new passengers up, so they have no choice but leaving the airport empty.

It is especially frustrating for the visitors, because as Washington Post estimates, the average waiting time for a taxi exceeds an hour. So this means that monopoly results in a deadweight loss because market equilibrium quantity would be higher than it is now. Price is also higher than marginal cost, and buyer surplus is lower than it would be under open market competition.

This arrangement is made between Dulles Airport and Washington Flyer, the monopoly taxi company in terms of picking up visitors. There is now a significant move from other taxi companies towards the city to end this monopoly which has gone on for years.

Source: Washington Post, October 12, 2005, page A16, www.washingtonpost.com/wp-dyn/content/article/2005/10/11/AR2005101101730.html.

The Brisbane concrete cartel

Concrete, a mixture of cement, gravel, sand, and water, is an essential input into building construction. By its very nature, concrete solidifies quickly; hence, once mixed, it cannot be transported over long distances. Suppliers must mix concrete at plants close to their customers’ construction sites. The land for mixing plants is a major fixed cost. Physically, concrete is a fairly homogeneous product.

In 1989, five major suppliers - Pioneer, Boral, CSR, Goodmix/Hymix, and Rocla - accounted for about 95% of the concrete market in Brisbane, Australia. Following a price war, the big five agreed to limit competition so that each could maintain its respective historical market share. In particular, they agreed not to poach customers from one another.

The big five held regular meetings to discuss upcoming concrete sales. The meetings allocated each sale to a particular supplier and fixed the price for the sale, with the other suppliers agreeing to quote a higher price or not to quote at all. From time to time, the meetings also arranged to raise the price of concrete.

To discourage cheating, each of the big five reported information on its sales volume, prices, and raw materials costs to a firm of accountants. The accountants collated this information as the Brisbane Concrete Survey. The big five used the survey to verify their respective market shares and to check whether anyone had undercut the agreed prices.

Generally, if a cartel succeeds in raising the price above the competitive level, it will attract new entrants. In 1991, Excel Concrete entered the Brisbane market. The big five responded by targeting Excel’s customers with extremely low prices. Further, Excel’s concrete plants were subject to opposition in local government councils. Two years later, however, Excel was acquired by the Holderbank group of Switzerland. Once the big five saw that Excel had stronger backing, they changed tack and invited Excel to join the cartel.

After an investigation by the Australian Competition and Consumer Commission, all the big five - Pioneer, Boral, CSR, Goodmix/Hymix, and Rocla - were prosecuted and fined for colluding on prices.

Source: Letter from the Australian Competition and Consumer Commission, December 14, 1995.

Cheating on the cartel: The German engineering industry

Under Germany’s system of national collective bargaining, an employer federation in each industry negotiates wages and other conditions with the corresponding labor union. By law, the national agreement between the employers federation and the labor union binds the entire industry. The result is wages and conditions that are uniform across the industry.

In the engineering industry, the employers federation Gesamtmetall spans international giants like Daimler and Robert Bosch as well as small businesses such as Bauer and Haeselbarth. IG Metall, representing 3 million engineering workers, is Germany’s largest union. In March 1995, negotiators for Gesamtmetall and IG Metall concluded a new collective agreement, raising wages by 3.5%, and cutting working hours from 36 to 35 a week.

Consistent with our analysis of monopsony, major employers have negotiated more favorable separate deals with their own workers. After Robert Bosch threatened to establish a competing factory in Scotland, its workers accepted more flexible working hours. Likewise, Daimler agreed to build a new line of compact cars in Germany only after workers conceded on wages.

The ability of large employers to reach separate deals reduces their incentive to press hard in the collective negotiations. By contrast, smaller companies have no such power. On learning of the new collective agreement, Bauer and Haeselbarth quit the employers federation. Managing director, Erhard Lenz, remarked, “There’s no unity among employers anymore.”

Source: “German Companies Sour on Centralized Bargaining,” Asian Wall Street Journal, October 18, 1995, pp. 1 and 12.

F-22 Monopsony

According to its US Air Force facts web page, “The F-22 Raptor is the Air Force's newest fighter aircraft. Its combination of stealth, supercruise, maneuverability, and integrated avionics, coupled with improved supportability, represents an exponential leap in warfighting capabilities.”

The plane’s designer Lockheed Martin has reported that it currently builds approximately 20 planes per year. Lockhead Martin’s web page describes the aircraft as such: “ No fighter in the world comes close to matching the F-22. By every measure, the Raptor represents extraordinary breakthroughs in maneuverability, stealth, sensor fusion - a wealth of parameters that define a new era in fighter capability.”

The aircraft was originally targeted to cost somewhere between 160-$200 million dollars depending on the year built and its electronics configuration. The US Air Force signed its original $5 billion contract with Lockheed Martin for early design work and originally planned to order approximately 750 planes but that number has been reduced numerous times and currently is about 183 aircraft. According to the 2009 US Air Force budget estimate, the total cost of the program from origination until 2006 for a total of 183 planes is roughly $62 billion. So the actual cost of each plane will end up being closer to 338 million per since the number requested as been reduced.

Unlike many other tactical fighters, the opportunity for export is currently non-existent because the export sale of the F-22 is barred by federal law. This includes sale of the aircraft to NATO partners and long-time allies. According a Feb 14, 2007 issue of The Australian, “The US Deputy (sic) Defence Secretary, Gordon England, has written to (sic) Defence Minister Brendan Nelson saying the US will not export the world's most deadly warplane - the F-22 Raptor - to Australia.” Japan, Britain and Israel have all expressed interest in buying the plane as well but Congress refuses to allow it to be exported to anyone.

Notably, Lockheed Martin’s slogan is, “We never forget who we are working for.” That shouldn’t be hard--They only have one customer for this product.

MONOPOSONY OVER?

A monoposony is a market situation where a seller can only sell to one buyer. In the case of a life insurance policy, this means the consumer can only sell the policy back to the issuing carrier for its cash surrender value. Life settlements have changed that and Coventry Financial, a pioneer in the field, has established a Life Settlement Coalition for providers and brokers to promote the benefits of life settlements to consumers. A major goal is to "encourage life insurance companies to advise policyowners they have an alternative to lapsing or surrendering their life insurance policy, and of the potential increase in policy value if they were to pursue a life settlement." On the other hand, all must not be well in the industry since CNA has apparently decided to deactivate its life settlement arm, Viaticus.

Source: http://www.fsonline.com/enews_archive/enews081501/enews0815.shtml