Global Comment

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The “Wage Puzzle”: How Companies Keep Employee Pay Low

Two storm trooper figurines waving paychecks

Among the more pessimistic and realistic of the economic commentators, questions regarding the long-term stagnation of wages has become a topic of serious interest. Why, when the American economy is experiencing the longest expansion in its history by conventional measures, have real wages been flat for the last four decades? This question, which has been given the cute title of “the wage puzzle,” has spawned numerous articles and academic endeavors. While no concrete answer has risen to the surface (and likely never will), one particular justification for this phenomenon has garnered the attention of a number of noteworthy economists.

A situation in which one employer dominates the labor market is referred to as “monopsony,” a term coined by the brilliant and underappreciated Joan Robinson. This, like many other empirical observations of the American and global economy, runs up against theoretical assumptions regarding economic interactions. Economist Bruce Kaufman writes “In a perfectively competitive labor market, something like monopsony does not happen.” The editors of The Economist write bluntly: “No reality-based economist would argue that labour markets are perfectly competitive.”

It seems that arguing against the existence of a competitive labor market would imply that there is some internal force preventing laborers from freely competing for the value of their wages. For many economists, monopsony is that force.

While one could argue that the literature on this topic is relatively new despite the age of the term “monopsony,” a consensus is beginning to take shape. Economist Efraim Benmelech finds a fairly strong negative relationship between wages and labor market concentration (particularly in markets with low levels of unionization). Not only has the phenomenon become more pronounced as time has gone on, Benmelech claims that his “results are consistent with firms exploiting workers in the form of lower wages.” Research by Jose Azar and Ioana Marinescu finds the same.

The Economic Policy Institute’s Heidi Shierholz and Else Gould write “even though monopsonists would like to hire more workers, the low wages they offer mean they can’t attract more workers unless they pay more.” If large employers would benefit more from hiring more workers (either at or below the market rate) would be a net gain for the company, they would. This seems to imply that America is currently in a position where, despite low unemployment, employers have no serious reason to raise wages or increase employment further.

Or rather, they have an incentive to keep them as low as possible regardless of how competitive wages fit into traditional economic models. While concentration in the market for employers reduces wages, it also allows for collusion between said employers regarding non-compete and no-poaching arrangements, legal agreements between employers not to hire one another’s employees for the sake of reducing their bargaining power. Litigation against such agreements has been, in the words of Suresh Naidu, “rare and mostly unsuccessful.”

There’s no justification in assuming that workers can freely move from job to job or have a serious degree of leverage in determining their level of compensation. Wages today are less a product of market negotiations than they are an edict passed down from one class of economic participants to another. In his speech to the Kansas City Federal Reserve, esteemed Economist Alan Kruger quotes Adam Smith, who wrote that employers “are always and everywhere in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate. To violate this combination is everywhere a most unpopular action, and a sort of reproach to a master among his neighbors and equals.”

Smith’s masters and their neighbors have an obvious financial self-interest in not paying workers. However, another perspective is worth considering. Research by the University of Chicago’s Simcha Barkai finds that “the decline in the labor share over the past 30 years was not offset by an increase in the capital share.” Conflicting results have been found regarding the capital share, but if we take Barkai’s findings as fact, this would explain why American businesses “currently have $1.9 trillion in cash, just sitting around,” as Adam Davidson writes in The New York Times.

American companies aren’t investing in labor, and perhaps not in capital either. While this could be the product of avarice, exploitation, and short-termism, it may also demonstrate a lack of confidence in the American economy on behalf of businesses to offer a healthy return on their investment. Neither one of these scenarios should be considered a positive omen for the future.

Photo: JD Hancock