Competition is good for your salary

Why workers should embrace competition to increase wages

Wages have been stagnant across much of the west over the last 40 years. Economists have blamed globalisation, innovation and an ageing population but perhaps the source exists within the market itself. David Cabrielli, a Professor of Labour Law, argues that we need to inject more competition into our job hunt, to boost wages and tip the scales away from corporations.


The West is in dire need of a pay rise. Indeed over the last 30 years, pay has fallen against the cost of living. But why is this the case? In recent months, stories about nurses, junior doctors, ambulance workers, transport workers and teachers taking strike action have hardly been out of the media. Not just in the UK, but also in the US, France, Germany, and other nations internationally. Trade Unions have been making pay demands to offset this most recent rise in the cost of living. Most reporting has focused on this source of the demands alone. However, trade unions are also calling on employers to make good real-terms declines in wages that have been sustained over 40 years of low wage growth. The British Medical Association for example is calling for a 35% pay rise to return to 2008 pay adjusted for inflation. To understand why wages have stagnated, it is useful to focus on why and how a decline in living standards may occur. But this wage stagnation goes deeper than energy price inflation.

To uncover the source of this stagnation, we need to understand a relatively unknown concept, that of monopsony. There are several causes of wage stagnation. First, the economy may experience sluggish GDP growth. This often arises where levels of productivity lag behind other countries, this being the change in economic value, per worker, per unit of time. Secondly, the cost of goods and services might go up, as in the current cost of living crisis where there has been an increase in the level of inflation. In the current environment, this is largely attributable to external factors such as the oil and gas shock generated by the war in Ukraine. Finally, there can be a fall in the standard of living if wages stagnate in real terms. Real meaning adjusted for inflation.

For the past forty years, wages have eroded in the UK and many other countries, when measured in terms of the GDP share. For example, what the statistics reveal is that the percentage of GDP paid out to workers in the UK as wages, income, earnings and salary – called the “labour share” – has dropped by around 5-6% since the early 1980s, while the proportion of income going to shareholders – called the “capital share” – has increased approximately by the same figure. While 5-6% may sound like a small figure, on the scale of nations this is an enormous sum. This equates to £52bn that would have gone to labour using 2022’ GDP.


Employers have extensive power over labour and labour markets are ever more concentrated


This is quite shocking, since until recently, economists had held firm to the view that the ratio between the labour and capital shares of GDP was constant so that if wages declined, the capital share would drop at the same rate and stabilise at the same ratio. However, recent statistical evidence has discredited that presumption.

The hunt for the cause of the labour share drop has been on for around a decade now. The list of the accused has included technological innovation, the ageing population, offshoring and globalisation as the prime moving causes, amongst other factors. But one of the more plausible claims that is gaining traction is that this sustained wage stagnation, expressed as the drop in labour share, is caused by increased monopsony power in the labour market.

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Monopsonies are less well known, but an equally pernicious mirror of monopoly. Where a monopoly is a market with a single seller, such as a patented drug or copyrighted concept, a monopsony is a market with a single buyer. In this instance, monopsony power in labour markets is responsible for wage stagnation. It is also important to note that monopsony and monopoly do not have to be absolutes for this form of power to exist. Indeed, very concentrated markets are also referred to as oligopolies or oligopsonies, derived from the ancient Greek for ‘Oligo’ meaning few. Incidentally, this is where the word Oligarch also comes from. Ultimately, whether pure monopsony or not, this market concentration is responsible for our current stagnation. Without many players, there can be no competition, and economists love competition.

For many years, economists had assumed that labour markets were neither concentrated nor uncompetitive. However, recent research has demonstrated conclusively that there exist very few employers in most markets compared to the number of employees looking for work. This translates into two things: employers have extensive power over labour and labour markets are ever more concentrated.

Where concentration and power of this nature exists, an employer in that market can manipulate its privileged position to pay a wage rate that is below an efficient market price. Wages, therefore, become disconnected from supply and demand, and worker productivity. But the potential to exploit this monopsony power is not restricted to the private sector. Such a dynamic may also exist in the public sector, where central Governments have a monopoly over the provision of a particular service.
Other than labour market concentration, the extent of monopsony is intensified by two additional factors. First, there is the so-called “job differentiation”. And secondly, the prevalence of barriers and the imposition of costs on the free and easy access of workers to change jobs.

The former “job differentiation” represents the idea that certain workers may have such a high degree of preference for their workplace, pay, and terms and conditions that they have no desire to search for another job and move to work for another employer. For example, consider commuting times, friendly co-workers, attractive workplace amenities, etc. That feeling that despite hating your boss, you would miss your colleagues.

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As for the latter, these are referred to as exit/quit and job mobility frictions. These represent the various factors that may discourage workers from exercising their right to quit employment and take up a job with another employer in the market. For example, consider the costs of relocating, whether there is sufficiently close access to childcare, nurseries and schools, as well as restrictive non-compete clauses that prohibit workers from working for the employer’s competitors for a period of time after they have left employment.

Economic models tend to assume labour can freely move between jobs with few barriers. This forms the basis of a competitive labour market. If you work as a doctor and you see that a different hospital is paying more, the rational decision is to change job. While you may love your current terms and conditions and colleagues, ultimately disparities in pay may result in you wanting to swap jobs. In turn, your hospital would see lots of doctors leaving and would raise pay to attract new ones. Thus, our market is competitive.

Monopsonies throw a spanner in this neat theory. Consider a doctor in the UK who may love his colleagues but wants higher pay. Seeing as the UK government is a monopsony employer of doctors, other than abroad there is nowhere else to turn. No competition to stimulate pay rises. Government monopsonies, and the restrictive legal practices I have described, prevent this wage rising competition. As a result, why would a company pay you more for producing more, they know how costly it will be for you to find another job.


Without many players, there can be no competition, and economists love competition


The argument that labour markets are rigged in favour of employers is nothing new. None other than the father of economics, Adam Smith, famously observed how employers used their monopsony power to drive down wages below the market-competitive rate. Where each of these three factors of concentration, job differentiation and exit-quit and job mobility frictions and costs are present in the labour market, real-terms wage stagnation becomes a realistic problem, which can lead to the industrial action we have seen in the past few months around the world.

But what might be some of the legal solutions that can address the exploitation of monopsony to encourage wages to re-build their share of income? One straightforward suggestion would be to reform the law that governs non-compete clauses so that their use, and enforceability, are cut back. In the absence of restrictive covenants, employers already benefit from the labour market power generated by job search, exit/quit and job mobility frictions. Research shows that the cost of moving jobs can be as high as $400,000 . The deck is already stacked in the company’s favour, there is no need to strengthen it further.

Of course, employers can increase this even further and heighten these frictions and costs by inserting post-termination restrictions into the employment contracts of their employees. If employment law were reformed to curb the excessive and easy use of, restrictive covenants against their former staff, this would be one modest measure to dampen down the labour market power of firms.

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Other useful employment law reforms would include a hike in the national minimum wage and the tighter regulation of “garden leave” clauses in employment contracts, which empower employers to insist that their staff stay at home without working after they have handed in a notice to quit employment.
Another effective prescription would be to change employment law to introduce maximum notice periods which would mandate employees to provide short periods of notice if they intend to change job. Job standardization measures and policies could also be introduced to “thicken” labour markets, e.g. greater use of standard form job grades and types.


But this wage stagnation goes deeper than energy price inflation


The phenomenon of widespread labour market monopsony has largely been overlooked in reports about the current bout of strike action and it is high time that it was discussed more widely in the media. Discussing current strikes as a result of inflation alone is short-sighted, and until the underlying causes of stagnant wages are popularised, the debate on this topic will be blinkered. Raising awareness among the public is key if policies and measures are to be taken to encourage a rise in wages. And this is where the law, particularly employment and competition law, can make a real difference. These branches of law can do so by addressing the various economic power structures that have given rise to the labour share decline so that a fairer balance between the return on work, as well as capital investments, can be struck with higher wages. With a little more competition, workers can get the pay they deserve, companies are incentivised to innovate, and my morning train may no longer go on strike. 

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David Cabrelli 7 April 2023