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.[1] 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?

[snip]

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.
_____
[1]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.

FILED UNDER: Borders and Immigration, Economics and Business,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Billy says:

    First, Coasian theory has little place in formulating real world policy; there is no such thing as a perfectly competitive market or a perfect monopoly, and to try to examine market forces in a vacuum is and should be left to idle ivory tower pseudo-intellectualism. But to address the point, this is not an apt comparison to the New Deal monopolies, because competitive firms are first driven by the profit motive, whereas the WPA programs were driven by a mission to create jobs. Two very different contexts that directly influence the choice of production levels effected at the firm level. As for regulatory devices like the NLRA, it is a mischaracterization to say that they existed only to “limit competition” – there were social concerns driving these policies as well as economic concerns. Viewed in the Chicago school ivory tower vacuum, no, they weren’t the most efficient methods of bringing about economic recovery, but that wasn’t their only goal.

    Second, comparing employment protectionism to a state-created monopoly creates a false dichotomy. The two policy arenas don’t even exist on the same plane, and cannot be analogous to each other. That’s why no one took the bait the first time around – the analogy makes no sense.

    I do agree that employment protectionism is a terrible idea in the long-term and doomed to failure in any event. But I question the way it’s been articulated here, you seem to try (unsuccessfully) to score a particular political point against the New Deal policy initiatives rather than making the very salient economic argument against employment and immigration protectionism.

  2. Steve Verdon says:

    I’m sorry Billy, but you just don’t know what you are talking about. I didn’t invoke any Coasian types of arguments, nor did I rely on prefect competition or perfect monopoly in ways that are crucial to my position. Try again.

  3. Billy says:

    As much as I hate to cite wikipedia, have a look at the entry for Perfect Competition. Your postulate that as a firm gets market power it necessarily reduces production is the natural consequence of learning about economics in an academic vacuum, decoupled from common sense or experience of how the real world actually works.

    I like your very well reasoned responses to the other points of my posts. Given the tone and general level of intellectual discourse evident in your reply, do you want to go ahead and call me a nazi now and get it over with?

  4. RJN says:

    I don’t think your challenge was, itself, very honest. You ignore the fact that we have to include the value of nationhood, and tax burdens, and expected rights after generations of doing it right for your country, and perhaps serving in the military, and or losing a child or brother while ostensibly serving the U. S. in your thought experiment.

  5. Steve Verdon says:

    Billy,

    While I cited competition in my footnote, I also closed that note with the following,

    The same result holds, qualitatively for markets that are between competitive markets and monopoly markets such as markets that are characterized as oligoply.

    In short,

    1. I’m aware that perfect competition in the real world is very, very rare.
    2. That perfect monopoly is also very, very rare.
    3. That despite this possible objection the qualitative aspects of the footnote hold when we move from one end of the continuum to the other.

    Hence your objection is without any merit and highlights at best a superficial understanding of economic theory and how to apply it to the real world.

    …do you want to go ahead and call me a nazi now and get it over with?

    Why, would it make you feel better or something?

    Oh and one more thing, I didn’t bring up the WPA, so agian an irrelevant point that doesn’t address in anyway the substance of my post.

    And guys like Hamilton are not your typical “Chicago type” as he went ot Berkeley to get his PhD.

    RJN,

    I don’t think your challenge was, itself, very honest. You ignore the fact that we have to include the value of nationhood, and tax burdens, and expected rights after generations of doing it right for your country, and perhaps serving in the military, and or losing a child or brother while ostensibly serving the U. S. in your thought experiment.

    Oh yes, lets drag in lots of emotional baggage so that we can make a decision based on emotion vs. logic, empirical evidence, and sound reasoning.

  6. RJN says:

    O. K. Working for ones family, or community, is the same thing as working for whoever some foreign wind blows in front of you. While you are at it, take your pension plans, and your medical insurance plans, and your C.D.’s, and stock certificates and throw them to a benign wind so they land in someone Else’s hands.

  7. Steve Verdon says:

    RJN,

    Your last comment makes no sense.

  8. Billy says:

    Steve,

    Try googling “Godwin’s Law.” It might aid you in developing the sense of humor that is so obviously lacking.

    You take your economic analysis very personally, particularly when arguing with an anonymous poster who agrees with your central point. Take a deep breath, man.

    BTW: You still never began to address the substance of my comment. Therefore I win.

  9. Steve Verdon says:

    Try googling “Godwin’s Law.” It might aid you in developing the sense of humor that is so obviously lacking.

    I’d suggest you use dictionary.com to look up the word sarcasm. Sheesh.

    You take your economic analysis very personally, particularly when arguing with an anonymous poster who agrees with your central point. Take a deep breath, man.

    I took nothing personally. Your comments were largely irrelevant and I said so.

    BTW: You still never began to address the substance of my comment. Therefore I win.

    Well, I hope you’re happy now that you have won.

    Oh and I apologize for the terse nature of my posts as it seems to have upset you.

  10. RJN says:

    You are a swell guy to put up with me, but may I ask a few of questions?

    Isn’t the bedrock of free enterprise self betterment? And, isn’t the bedrock of community and participatory government the family? Aren’t these the glue of a Nation, and isn’t emotion involved?

    If we spurn these qualities, and consider them useless in economic affairs; in other words, if we say to one-half of our population – “We don’t respect your contributions enough anymore, you don’t get consideration as full citizens anymore” – are we still a Nation?

    Another thing that matters is the fact that we are keeping too much technological development from our own workers and industries by letting it all happen outside of the U.S.

    In any case my proposal has always been to collect duties, or tariffs, on mfg. goods from abroad and apply the proceeds to Soc. Sec.

    I still think your proposed experiment is apples and oranges.

  11. Steve Verdon says:

    RJN,

    I didn’t say that self-betterment or that participatory government are irrelevant or unimportant. My point is that when competition is allowed in economic endeavors, things get better. When competition is stifled things tend to get worse.

    Limiting immigrant workers on economic grounds falls into the latter catagory. Controlling our borders for security reasons is very sensible and something we should do. But this idea that there is an economic bonus or that it is also good for the economy is almost surely not true.

    As for taxing imports, that has basically the same effect. It gives the domestic industries market (increases monopoly) power. If it works on an international trade basis, why not do it on a domestic basis.

  12. RJN says:

    One more thing, please, and I will leave you alone for a time.

    I meant to point out that protectionism is most rampant, and most expensive, in government and education. To see protectionism at its’ most excessive, look at government and education employee unions and their efforts against lack of employment, or reductions in compensation

  13. Billy says:

    Well, I hope you’re happy now that you have won.

    I totally am. Thanks!

  14. Steve Verdon says:

    One more thing, please, and I will leave you alone for a time.

    I meant to point out that protectionism is most rampant, and most expensive, in government and education. To see protectionism at its’ most excessive, look at government and education employee unions and their efforts against lack of employment, or reductions in compensation

    I agree, RJN, but on this issue you are preaching to the choir here.