Do Economists Understand How Power Shapes the Labor Market?

Even liberal mainstream economists often overlook the role of coercion in setting wages.

It was a great pleasure to read one of Paul Krugman’s columns over the holidays, entitled "The Fear Economy." I’d say it’s my favorite of 2013 because he took a decided step away from standard orthodox theory. Even Krugman rarely does that. His welcome and thankfully influential liberal ideas usually fall well within the scope of mainstream theory.

This was not the case in his December 27 column, or so I interpret it. Krugman talked about “power” in the labor market. When there aren’t enough jobs around, workers lose their bargaining power, he wrote, and they can’t maintain decent wages. This was a major statement by a Nobel winner.

Why? Well, the typical reader might say, “Of course there is power in the labor market. And unless there are labor unions or a low unemployment rate, the power belongs to the employer to set wages and hire and fire. What else is new?" But if you were an economist, odds are you wouldn’t say this. Power plays a peripheral role, if any at all, in conventional economics.

The invisible hand, remember, is, as Milton Friedman defined it, “coordination without coercion.” And the invisible hand, the mainstream believes, rules the labor market as it does most others. That is to say, no coercion. This is just not a view of Chicago School conservatives.

What does Krugman think? “Now, you may believe that employment is a market relationship like any other — there’s a buyer and a seller, and it’s just a matter of mutual consent,” he wrote in a blog post a few days earlier on the same subject (in which he nicely referenced the Roosevelt Institute’s Mike Konczal). “You may also believe in Santa Claus.”

Apparently most orthodox economists believe in Santa Claus. They claim workers are paid what they deserve, just as businesses pay the going price for copper or software. That price is reached fair and square through competition. If more workers are needed to produce the goods and services demanded in the economy, their price—that is, their wage-- goes up. But if fewer workers are needed, their price goes down.

That labor is paid what it deserves is a central tenet of modern capitalism. It is partly why economists believe that if you raise productivity, or output per hour of work, wages will follow. But productivity has been rising moderately strongly for a couple of decades and wages simply haven’t kept up.

And as Krugman notes, the rate at which workers quit their jobs has stayed very low. In other words, they are afraid to do so.

In conventional economics, the efficient and fair workings of the invisible hand are only disrupted when competition is artificially restrained by monopolistic or oligopolistic practices. In the labor market, that would mean there are too few businesses, so they don’t compete for workers. In practice, many and probably most economists rarely worry about that. They do worry about how labor unions might reduce competition on the other side of the equation, “coercing” wages up.

And it explains why so few economists have urged a substantial increase in the minimum wage until recently. If labor markets set the wage fairly, an artificial increase would reduce jobs. But if power is involved, a minimum wage regulation can offset the coercion from the top.

When Alan Greenspan was chairman of the Federal Reserve, he watched the quit rate mentioned by Krugman closely. If it got too high, he worried that pressures to ask for wage increases would build and lead to inflation, so he would have to step on the monetary brakes to get the unemployment rate back up.

I think Greenspan, an orthodox if highly ideological economist, probably believed fully in the invisible hand. So why did he worry about worker bargaining power? Maybe he thought that if the market were working properly, without help from unions, the quit rate would always be low. He seemed delighted when the quit rate remained low.

This is not to say there are no intelligent ways to talk about power within the orthodox conventions. One noted problem is a lack of adequate information to bargain and choose fairly, for example. Another is a famous theorem of Ronald Coase that differences can be negotiated, but I think that falls under the same principle of power.

Maybe the neglect of power is changing now, however. An economist calculated that in the Journal of Economic Issues -- granted, a left-wing journal -- there had been 44 articles with “power” in the headline since 2008, more than in the previous 16 years.

What is power? I’d call it the ability to make someone do what they don’t want to do. It's coercion by any other name, and it exists in modern labor markets. That’s a good start, anyway. And maybe soon we’ll start shedding some other myths of mainstream economics.

(From Roosevelt Institute)

Jeff Madrick

Senior Fellow at the Roosevelt Institute and Director of the Bernard L. Schwartz Rediscovering Government Initiative. His latest book is Age of Greed, The Triumph of Finance and the Decline of America, 1970 to the Present, published by Alfred A. Knopf in the Spring of 2011.