Market Power, Wages, Unemployment and Economic Policy
A while ago in writing about the new calls for protectionism on both the Right and the Left I wrote the following,
But the thing is that we can’t prosper and protect jobs from competition overseas. It is like trying to prosper by moving to an isolated location and producing everything you need. While you might be able to do it, you lose out on specialization that comes with market economies. In international trade the idea of specialization is called comparative advantage and is the driving idea behind why free trade is a good idea. Think of it this way. If protectionism is a good thing for a country why isn’t a good thing inside that country? Why not give a specific firm in a given industry protected status in that it does not face tariffs that all of its competitors face? Why not create a single firm in each industry that way it can hire people and pay them lots of money in terms of wages which in turn will stimulate demand and thus bring about economic nirvana.
Nobody took the bait and tried to defend the above notions. Probably because they know they can’t be defended…which interestingly enough makes the proponents of the various calls for protectionism intellectually dishonest at the very least (although I suppose for some they just don’t have a clue how to defend the above position).
James Hamilton makes the same point, but in relation to a discussion of whether or not some New Deal policies actually prolonged the Great Depression (the answer is, “Yes,” and anybody who seriously believes otherwise is just being foolish),
The notion that if we can just create more monopoly power for every single sector of the economy, encouraging every sector to produce less so they can raise their wages and prices, that we will then somehow make everybody richer, is so spectacularly wrong-headed…
That is exactly right. The problem is that when a firm gets more market (monopoly) power it reduces production. After all, what happens when the supply of something decreases, but demand stays the same? The price goes up. This is one of those conclusions in economics that just about every economist will agree with. What did we see during the Great Depression then the National Industrial Recovery Act of 1933 and the National Labor Relations Act of 1935 were enacted? We can turn once again to Prof. Hamilton,
What is supposed to help the economy recover is that a substantial pool of unemployed workers should result in a fall in wages and prices that would restore equilibrium in the labor market, as long as the government just keeps the money supply from falling (which, as just noted, the Fed failed most spectacularly at doing during 1931-32). And yet, in the midst of quite significant unemployment, between 1933 and 1934, average hourly earnings increased by over 25% in sectors such as iron and steel, furniture, and cement, and over 50% at lumber mills. How could that be?
Cole and Ohanian noted that many in the Roosevelt Administration believed that the severity of the Depression was due to excessive business competition that led to wages and prices that were too low. I actually agree, in a perverse sense, with part of that diagnosis– I see the rapid deflation of 1929-33 as quite destabilizing. But I’m inclined to believe that the way to fix that would have been through a monetary and fiscal expansion rather than trying to lift nominal wages and prices back up by sheer government fiat.
The purpose of the NIRA and NLRA was to promote labor and trade practice provisions so as to limit the extent of competition between firms and competition between workers. Among the NIRA codes that Cole and Ohanian highlight include minimum prices below which firms were not allowed to sell their products, restrictions on productive capacity and the amount that could be produced, and limitations on the workweek. Cole and Ohanian concluded on the basis of model simulations that these kinds of New Deal policies might have accounted for 60% of the persistence in the output gap.
So you might get an increase in the wages of say those who hang dry-wall, but you will likely get a contraction in the number of people employed in that area and you’ll also get an increase of people looking for work in those areas. The result: more unemployment. Congratulations you now support, as official government policy, increasing unemployment. This is why the economic arguments, in my opinion, against immigrant workers is just…well wrongheaded to use Prof. Hamilton’s expression. Controlling the borders for security reasons makes more sense, but also alllowing in those who are not security threats who are simply looking for a better life and work also makes sense. Economic competition has tended to promote growth, improved living standards and so forth for all involved. Not immediately to be sure, and with some adjustments that for some can be painful. However, trying to prevent competition instead of trying to make the adjustments smoother and less painful is just a foolish policy perscription.
A competitive firm will produce to the point where marginal cost = marginal revenue = price. The reason for this is that the firm has no market power and hence any changes in output has no effect on price. For a firm with market power this is not true. The firm will still produce to the point where marginal cost = marginal revenue, however both sides of the equation are functions of output. That means that marginal revenue is no longer simply the price. Price is then determined by the output determined by the equation of marignal cost and marginal revenue and since the marginal revenue is everwhere below the demand curve it follows that price > marginal revenue and hence that output is lowered under monopoly than with a competitive market. The same result holds, qualitatively for markets that are between competitive markets and monopoly markets such as markets that are characterized as oligoply.