In March 2018 we published the first version of this note describing some of the characteristics of monopsony, a phenomenon increasingly present in the labor markets of Latin America and the Caribbean. Six years later, we decided to update this blog with new references and recent data that account for a major market failure and may be one of the causes of persistent low labor productivity in the region.
Several decades—and a few extra pounds and gray hairs—after first studying the concept of a perfectly competitive labor market, I am still amazed by its beauty. In this type of market, there is no need for government intervention because, almost magically, a balance is achieved between employers seeking workers and workers seeking jobs. If the government sets a minimum wage that is too high, unemployment follows, since employers will not be willing to hire as many workers at that wage. On the other hand, if the government sets a wage ceiling, the number of workers that firms want to hire exceeds the number of people willing to work at that rate.
Beyond its academic beauty, I continue to believe the lessons of this model should guide public policy design. But as economist Dani Rodrik says, “It’s a model, not the model,” and many types of market failures must also be considered—including monopsony, which is gaining increasing attention.
What Is Monopsony?
Less well-known than monopoly, monopsony occurs when many people are seeking jobs but there are only a few employers—who, due to limited competition for workers, can afford to offer lower wages than they would if they had to compete more for available talent. In this case, we can say that companies have “more leverage” in the relationship with the workforce.
In addition to being harmful to workers, this model leads to an economically inefficient outcome: mutually beneficial hires between employers and job seekers don’t happen. For many years, the theoretical possibility of monopsony was not considered relevant for practical analysis or public policy. However, several recent studies suggest monopsony is indeed a real and pressing issue—for example, this study using data from careerbuilder.com and another based on an online crowdsourcing platform.
“Monopsony occurs when there are many people looking for work and there are only a few employers, who can afford to offer a lower wage than they would have to offer if there was more competition for workers.”
Where Does Monopsony Occur in Latin America and the Caribbean?
A common reaction in developed countries is to doubt that monopsony could occur in emerging economies. Yet, growing evidence shows that not only does monopsony exist in Latin America and the Caribbean, and it also has significant implications for public policy.
A 2023 IDB study, for instance, found that workers’ wages are, on average, 46% lower than the value they generate for the firms they work for. Another study also found that this wage-productivity gap is greater in countries where collective bargaining is less common or unemployment protections are weaker. And this study revealed that a Mexican labor reform banning outsourcing—introduced to address monopsony—resulted in higher wages for workers.
Yet another study found that monopsony doesn’t just harm workers by depressing wages—it also undermines national productivity. In Peru, for example, the study found that monopsony leads to lower productivity because people are not employed in roles where their output would be maximized. Employers, especially the most productive ones, hire fewer workers than they should from a national productivity standpoint, because hiring fewer people allows them to keep wages lower.
In other words, the monopsony problem in Latin America and the Caribbean shrinks the “size of the pie” that workers receive in return for their labor—not only because they get a smaller slice of the output, but also because overall productivity is lower, meaning a smaller pie for everyone.
The Role of Public Policy
The monopsony problem has at least three major implications for labor market policy.
The first concerns the minimum wage. In a monopsony model, a small increase in the minimum wage can increase employment, which could explain why empirical studies do not find the negative effects of minimum wage increases that the perfect competition model predicts. However, when the minimum wage reaches a critical level, continuing to increase it would have the same harmful effect as in the perfect competition model: higher unemployment (or informality). In this sense, the existence of monopsony may justify using the minimum wage to improve labor market performance, but not overusing it.
The existence of monopsony may justify using the minimum wage to improve labor market performance, but not overusing it.
The second implication for public policy has to do with the importance of labor unions. According to the U.S. Council of Economic Advisers, unions can serve as a counterweight to employers’ bargaining power and their unilateral use of “monopsonistic power,” promoting higher wages, better working conditions, and even more efficient employment levels. In other words, the presence of monopsony in countries may justify efforts to reverse a long-term trend of declining unionization. In fact, a recent study found that the negative impact of monopsony on wages is smaller where a larger share of workers are represented by unions. This study also found that the link between productivity and wages is stronger when unions have more representation.
The presence of monopsony in countries may justify efforts to reverse a long-term trend of declining unionization.
The third implication is perhaps the most obvious. Just as there are efforts to combat and regulate monopolies, experts are beginning to look at how to regulate monopsony. For example, Alan Krueger and Eric Posner propose strengthening the monitoring and scrutiny of mergers between companies to detect adverse effects on the labor market. Likewise, Krueger and Posner suggest strengthening and increasing the power of workers by prohibiting agreements that prevent low-wage workers from seeking employment in companies that compete with their current employer. They also propose banning agreements between branches of a single company from competing for the same workers.
Nevertheless, it is possible that the best way to combat monopsony is to promote an environment where more high-productivity companies compete for available labor. One study, for example, finds that an economic environment with both high- and low-productivity firms exacerbates the monopsony problem because the few high-productivity companies face no competition in the labor market. In this sense, fighting monopsony involves not only measures traditionally associated with “worker protection,” but also policies typically linked to promoting productivity.
Combating monopsony involves not only measures traditionally associated with “protecting the working class”, but also measures associated with promoting productivity.
Monopsony Versus Perfect Competition
My impression is that the debate on the best public policies in the face of monopsony is beginning. Policies aimed at strengthening the bargaining power of workers or limiting the power of employers are justified by the evidence of the monopsony problem, but we should not forget the warnings of the “classic” model altogether of perfect competition over excessive state intervention. In my opinion, the mistakes of “praising too much the virtues of the free labor market” and “ignoring the unforeseen consequences of intervening too much in a market” are equally common and dangerous.
Given the growing interest in the topic of monopsony we arrive at two conclusions that go hand in hand with the growing empirical evidence of its existence:
- First, worker protections designed to give employees a larger share of the pie can also serve as an incentive to create a more productive labor market—that is, they can help grow the pie—provided they are implemented in a measured way.
- Second, a productivity agenda aimed at increasing the size of the pie can also end up giving workers a larger slice. This is how we see opportunities in Latin America and the Caribbean to improve working conditions: by giving workers a bigger share of a larger pie for all.
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