Wednesday, February 21, 2007

Power and the Market

The argument on Chris Dillow’s blog that the Bowles & Gintes study he has recently cited identifies genuine power within labour market transactions appears to me to be deeply flawed. I’m going to first deal with a separate argument in Chris’s piece before moving on to discuss Bowles & Gintes.

Chris makes a classic, and at times credible, left-wing argument for power within the labour market; that some employers have power over employees because there are imperfections in labour markets. His example of City law firms with particularly prestigious and demanded jobs exists, I would guess, thanks to barriers to entry in the form of a need for an established reputation. A more conventional example would be that of a town with only one major employer. His other argument, that employees have less wealth so lose more if they are fired than employers lose if they resign, is dependent upon this as in an efficient labour market they would find another employer. I would argue that these labour market inefficiencies go both ways as superstar employees are just as rare and coveted as jobs at superstar firms. The best solution would seem to be to widen the range of plausible employers/employees. Freedom of movement within Europe probably contributes to this along with an increase in cultural willingness to move between regions and a decline in other institutional barriers to movement (the Poor Laws are a famous, if rather old, example of legislation which inhibited movement of labour). I’ll make a controversial but credible claim at this point: the railways, through their impact on the perception of distance and the cost of travel, did more to lessen inequities in labour market power than the unions.

Now, onto Bowles and Gintes’ argument which is summarised by Dillow here (I’ve corrected average wage to market-clearing as I think that’s what he means… sorry if I’m mistaken):

“But, say Bowles and Gintis, bosses' power is more widespread than this. It exists in any job where efficiency wages are paid - that is, where the firm pays [above market-clearing] wages in exchange for above-average effort. In such firms, bosses have power over workers because the threat of the sack is credible and worrying, as the worker could not get such a well-paid job elsewhere. However, workers don't have symmetric power over bosses, as the threat to leave is not credible.”

This is then supposed to feed into allowing bosses to sanction employees without suffering in return. However, employees would not be paying efficient wages if they were not getting something in return. The Wikipedia article summarises some proposed benefits to a firm of paying an efficiency wage:

• “Avoiding Shirking: If it is difficult to measure the quantity or quality of a worker's effort -- and systems of piece rates or commissions are impossible -- there may be an incentive for him or her to "shirk" (do less work than agreed). The manager thus may pay an efficiency wage in order to create or increase the cost of job loss, which gives a sting to the threat of firing. This threat can be used to prevent shirking (or "moral hazard").
• Minimizing Turnover: By paying efficiency wages, the employees' incentive to quit and seek jobs elsewhere is minimized. This strategy makes sense because it is often expensive to train replacement workers.
• Adverse Selection: If job performance depends on workers' ability and workers differ from each other in those terms, firms with higher wages will attract more able job-seekers. An efficiency wage means that the employer can pick and choose among applicants to get the best possible.
• Sociological Theories: efficiency wages may result from traditions. Akerlof's theory (in very simple terms) involves higher wages encouraging high morale, which raises productivity.
• Nutritional Theories: In developing countries, efficiency wages may allow workers to eat well enough to avoid illness and to be able to work harder and more productively.”

Just as an employer might pay an employee more if they can offer better skills or longer hours they might pay them to be more loyal or offer the other benefits of an efficiency wage paid worker. If they are to sanction employees, to use the power they supposedly possess, then that must necessarily reduce the loyalty of their employees (or the other benefits of an efficiency wage). Every use of the power granted by efficiency wages also carries a cost with its use in the opportunity cost of other uses of the funds required to pay efficiency wages whose influence has now been spent. If they misuse this power they have to be less efficient than other employers and competition will see to them. This would not appear to be a Pareto inefficient result because employers pay very directly for any exercise of influence over their workers and there is no reason to think either side is acting irrationally.

These limitations and costs to market power illustrate that it is profoundly different to political power. If power is something which is bought and only maintained so long as it is in the interests of the person you have power over to remain within your control is it really power at all?

Efficient wages buy a service just like regular wages and one of those services is reliability; this is very similar to the standard influences of money and very little like power.


chris said...

I must disagree here. You're right that employers only pay an efficiency wage if it maximizes profits. But the point B&G make is that a small move away from this wage imposes only slight costs upon the company; slightly higher wages, for example, would induce slightly more effort.
However, for the worker, losing such a job would be a big cost - especially if his human capital is firm-specific. It's this difference - plus the fact that workers are more substitutable than employers - that gives firms some power.
Neither B&G nor I claim that firms' power is generally more oppressive than government power. The claim is merely that the market is not the oasis of liberty and equality sometimes claimed.

Matthew Sinclair said...

Firstly, they don't have to leave. They can be slightly less "efficient" (whatever it is the efficiency wage buys) and have presumably lost a very similar amount to what the employer has lost.

Secondly, why is losing that job a particular cost? Surely if paying an efficiency wage for that worker is worthwhile for one company it would be worthwhile for another?

That result holds if their human capital is firm-specific, there is only one employer or something similar. This is the first part of your labour market power equation and one that is certainly credible although increasingly limited. I'm not sure what B&G add.