Market Power and Minimum Wage

A common argument in favor for minimum wage is that a legally established wage is necessary because firms underpay low-skilled workers.  How do they know these workers are underpaid?  Because those workers say so.  Why are they underpaid?  Because they lack market power.  Minimum wage, some proponents argue, merely correct this.

However, from an economic point of view, this argument doesn’t hold much water.

Remember that a worker’s compensation is determined by his productivity.  A more productive worker will earn more.  The only way for a worker to be underpaid is if he is making less than the marginal productivity he adds to the firm (this is true for everyone from the minimum-wage intern janitor to the CEO).

If a worker is underpaid, this creates a profit opportunity for a rival firm.  If the rival firm sees a worker is underpaid, he can make a higher offer to the worker (one more in line with his productivity) and entice the worker away.  In fact, firms do this all the time: it’s called headhunting.  Due to this threat from rivals, it incentivizes the employee’s current firm to pay him what he’s worth or lose him.

This theory holds true even for minimum wage workers: minimum wage establishments compete with one another for business and employees.  If one firm is perpetually underpaying its employees, it will face heavy turnover.

Some minimum wage workers (and many minimum wage proponents) feel the workers are getting a raw deal, that they are underpaid.  I suggest a simple test to determine if this is true: look for another job.  If a worker is able to find a higher-paid job, then he was underpaid at his old job.  If he is unable to find a higher paid job, then his perceptions about the value of the service he provides (in this case, his labor) is incorrect.

Sometimes a person will value his labor higher than it actually is.  Simply because he incorrectly overestimated his price does not mean he lacks market power; it simply means he overestimated.

6 thoughts on “Market Power and Minimum Wage

  1. The best refutation of the unequal market power, bargaining position, arguments is that the largest, most profitable firms pay the best wages and have the best working conditions. The small firms barely squeaking by with the least so called market power are the very firms that pay the lowest wages with the worst working conditions. This is exactly the opposite of that which the unequal market power or bargaining position arguments would predict.

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    • This might be true for in tech, finance and professional sectors — but it is patently false in retail (Walmart, Target, Macy’s, …), and food service (McDonalds, ARAMARK, Subway, …).

      The free market is a wonderful thing. But in the labor market, low-skill individuals can and often are unable to negotiate for a fair wage. You must be blind to the real world around you, or blissfully privileged, to believe otherwise.


  2. Good job!

    I am an acquaintence with a subway owner, who patrons nearby fast food eateries. He isn’t there for the quality food as he prefers to eat his own sub concoctions over the Taco Bell, Jack in the Box, etc. He visits to watch employees of the eatery. He makes several visits, picks out the ones who seem the most competent and hard working. After several of these visits, he talks with them, and if his impromptu interview goes well, offers them a job with better pay, assuming his offer is better.
    This is how he fills open positions.

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