Monopsony in Labor Markets: An Under Discussed Cause of Inequality

Monopolies are generally agreed upon as bad things because they lead to higher prices, less supply, and lower innovation. The US has an existing system built out to prevent their creation through antitrust laws like the Sherman Act and agencies like the Federal Trade Commission (FTC). There are several famous examples from the past of antitrust cases concerning companies like Microsoft and AT&T. Concerns about monopolization around the largest US tech companies today regularly make headlines like here, here, and here.

However, there has been less discussion and policy rules about a related issue: monopsony. This refers to the idea that in a market there is a single buyer (instead of a single producer in a monopoly). Monopsony causes similar problems though, especially in the context of labor markets.

When a single firm is the only company looking to hire workers, they have power over wages because there is no one competing with them for labor, giving the firm the ability to set lower wages and the general terms of employment. Some scholars have also argued that monopsony can explain discrimination in labor markets.

At a macro level the US labor market does not appear to suffer from monopsony. There are a healthy number of firms wanting to hire employees, and the unemployment rate today is very low, resulting in competitive labor markets as firms need to compete to hire workers. That state obscures differences in geography today and over time though.

Anecdotally we have heard stories of large companies closing up shop in small, rural areas, which can devastate local economies. Whether companies remove jobs because of globalization (the China shock), automation (robots), or both is beside the point. The fact that the loss of a particular type of job or employer could devastate individual geographic regions suggests those places suffer from monopsony problems because those companies were the sole major source of employment and likely acquired major influence over local wages and hiring practices.

Indeed in the typical state, the fraction of workers at large firms (those with more than 10,000 employees) has risen over time along with both the number of large firms and share of large firms relative to all companies. Thus, the typical state is seeing its local labor market become less competitive and more concentrated as firm size increases, enabling them to exert more control over local labor.

When we compare the average wage in states over time (adjusting for differences in the cost of living and the fact that wages generally go up over time), we see a negative relationship between wages and both the fraction of workers in large firms in a state and the state’s labor market HHI (a measure of concentration used by the government in antitrust cases).

This suggests that states with larger firms and less employment choice see depressed wages for workers, exactly as we would expect, and the problem is not equally distributed across the US as we can see below where darker red indicates states with a larger share of employment at large firms. Part of the reason why wages are lower in states is due to this monopsony problem of large firms exerting their market power to lower wages.

Take West Virginia, where in 2014 almost 30% of workers were at large firms. It isn’t a coincidence that over time wages for the average worker in the coal industry have stagnated relative to executive pay; this concentration of local employment opportunities at a few firms in the coal industry created a power imbalance whereby mining companies could depress worker wages because of a lack of alternative jobs.

A part of the widening income inequality in the US can be explained by monopsony problems in local labor markets as the spatial concentration of employment opportunities drives down wages and reduces labor market competition. Pushing policies across states like banning non-compete agreements, allowing unionization, and reforming occupation licenses can reset this power dynamic between firms and workers and help drive higher wages and economic prosperity for workers.