Monopsony in the Labor Market

This explainer expands on the labor demand and supply in a monopsonistic labor market, exploring the effect of collective bargaining by trade unions on such a market structure.

Shereein Saraf

Shereein Saraf

March 12, 2021 / 8:00 AM IST

Monopsony in the Labor Market

This explainer expands on the labor demand and supply in a monopsonistic labor market, exploring the effect of collective bargaining by trade unions on such a market structure.

Remember playing the board game – monopoly – with your friends or family on that long weekend afternoon. Everyone has had such an experience, at some point in their lives, most likely during the pandemic-induced lockdown. Some played to collect more and more properties, reach Broadwalk or Mayfair – the most expensive properties (in USA and UK version, respectively) on the board, and build houses and hotels along the squared path. Others discovered the art of managing assets, rents, mortgages, and loans, to eventually emerge as a monopolist. 

Monopsony lies on the other extreme of the spectrum of distribution of market power. While monopoly has a single seller controlling the market, monopsony has a sole, powerful buyer. There are unlimited buyers in the former, whereas countless sellers in the latter. 

In the labor market, when an employer within a particular firm or industry influences decisions regarding the purchase of labor time and effort, the market power rests with the employer – the monopsonist. It gives the monopsonist authority over appointing employees and control over their wages, which in some cases tends to undercut minimum wages. On the supply side of this dynamic lie the labor who enter the market with a reservation wage – a pre-conceived wage threshold at or above which the worker would be willing to work. 

A case in point is De Beers, once the monopolistic diamond producer with a market share of over 80% in the 1980s. Besides, it is the monopsonistic employer of diamond workers in South Africa. Coal town companies usually employ local people to work at their mines, operating as the sole purchaser of labor supply. 

Silicon Valley, which is home to the tech giants – Google Inc., Apple Inc., and many more, is another example of monopsony in labor markets. These technology giants do not compete with each other as the skillsets required at one company are redundant for the other, thus, holding power to influence wages. While Apple would be looking for a creative product designer, Google would be hiring a sharp software engineer, which requires different competencies, thus, in most cases, distinct applicants, unless someone has mastered both product and software design. 

Such tendencies have exasperating effects on the labor market. Income inequality among genders, regions, and industries intensify. For one, a wage lower efficiency wage affects womens’ employment opportunities and their respective compensations. Women, who generally work in low-skill, low-pay jobs, are at risk of being replaced with men or a younger college-going demographic willing to work at lower pay. Similarly, a single employer with the power to influence the regional workforce participation limits workers’ options to find work. 

Even public sector industries and services, such as the postal offices, and in some cases, the railways, which are large employers of labor, could undermine minimum wages, and if not, could undercut efficiency wages. However, gathering support to constitute a trade or labor union could combat the employer’s monopsony. Trade unions work for the welfare of the workers. If they collectively decide on a minimum wage, the employer will have no other way out. The trade union becomes the sole supplier of labor. This mechanism is that of collective bargaining between the union and the employer. 

In many cases, forming a union is forbidden on the signing of the contract. But in other industries, labor unions play an indispensable role in shielding the workers, especially within the informal sectors, from wage cuts or no increase in wages despite the rising inflation and redresses the lack of social security and employee benefits. 

With evolving market structures, thus, the labor market theories, new evidence has come to light. A monopsony, as explained in the paper entitled Monopsony in Labor Markets: A Review, authored by Alan Manning, does not necessarily assume labor supply to be infinitely elastic, suggesting a weakening of monopsonist’s power. Following this premise, if the employer cuts wages, recruitment and retaining employees will become harder, and not otherwise. 

A minimum wage, thus, does not reduce employment in the economy. This statement is not only valid for a perfectly competitive labor market but also a monopsonist market. In addition to securing work, wages provide a mechanism to monitor as well as retain employees. The more the wages, the better the productivity of labor and compliance to hours. 

In an economy with macroeconomic assumptions of no voluntary unemployment within the labor supply intact, lower unemployment rates indicate ease in finding work. The turnover rates, or the rate at which employees choose to shift jobs, tend to increase as a result. It is in the employer’s interest to compensate the employee with a wage well above the minimum wage. The strenuous process of hiring new employees demands a lot of time and trouble. A higher pay lessens the possibility of finding a competitive salary, ensuring the employee stays with the firm a little longer. 

Despite this all, no market complies with the idea of an absolute monopsony as labor suppliers will always find alternative channels to sell their time and effort. This analysis is a medium that serves to understand the prevalence of a near-perfect monopsony in a few labor-extensive sectors.