The labour-monopsony myth

Gerard Jackson
BrookesNews.Com
Monday 24 December 2007

Some readers have asked my to try and clarify further the fallacy of monopsony with respect to labour. To recap: Unions and their supporters argue that "market failure" results in the emergence of monopsony, i,e., a sole purchaser of certain types of labour. Because, as the graph below shows, each additional worker added to the payroll means that average costs will exceed marginal costs. The result is that wages and output will be lower than would be the case if wage rates were fixed at a point between 'A' and 'C'. Therefore a union or a government wage-fixing body must step in to put the capitalist right about pricing labour.
monopsony and labor
Our union officials are completely confused on this issue. For instance, Grant Belchamber, the ACTU's chief research officer, categorically stated in the union study the Impact of Safety Net Adjustments on Wages and Jobs that marginal productivity is a false theory. Yet on page four of the very same study we find union researchers using monopsony theory to justify raising real wages, even though this theory is based on marginal curves! Unfortunately the H. R. Nicholls Society — a self-appointed group that makes the risible claim that it defends free labour markets — not only failed to detect Belchamber's glaring contradiction, it also swallowed his monopsony approach.

The HRNS argues that the number of firms in the Australian economy makes it highly unlikely that monopsony could emerge. Once again: numbers have nothing to do with it. There are two basic flaws in the theory. The first one should be self-evident. No firm ever sets up operations in the manner assumed by the theory. In other words, the theory's basic assumption that a firm hires workers one at a time is pure baloney. Therefore, the

. . .process of building up the working force from a single unit is imaginary. In practical life we see the process only in its final stage. Entrepreneurs do continually have to test the effect of making their working forces a little larger or a little smaller, and in so doing they test the final productivity of labor; and this is all that is necessary. (John Bates Clark, Essentials of Economic Theory, Macmillan Co. New York, 1924, p. 140).

This leads to the not-so evident fact that monopsony theory is based on a misapplication of marginal curves. It follows from this that when planning to set up a firm the entrepreneur applies the "average cost" approach. Thus:

If the entrepreneur is still free with regard to the project in question, because he has not yet made any inconvertible investments for its realization, it is average costs that count for him. But if he has already a vested interest in the line of business concerned, he sees things from the angle of additional costs to be expended.(Ludwig von Mises, Human Action, Henry Regenery Company, 1963, p. 343).

We can now see that the idea that labour needs to fear the emergence of a monopsony situation is totally baseless. It's a great pity that the HRNS lacked the intelligence to figure this out for itself.

Gerard Jackson is Brookesnews' economics editor