Asymmetries in bargaining

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The big lesson from Adam Smith is that people trade when there is benefit to both sides from doing so. If the widget is worth a dollar to the owner, but it's worth two dollars to a potential buyer, then they'll find each other and trade, maybe for $1.50, and both sides are better off by fifty cents. I.e., the seller gave up a dollar in value in the widget but gained $1.50 in cash while the buyer gave up $1.50 cash but gained two dollars in widget value. We conclude that letting people trade is a good thing, and the more trading the better.

The question that the rest of this column asks is: how is that dollar surplus divided? Pricing at $1.50 seems fair, but any price between $1.01 and $1.99 will work.

The bigger side wins

But there are also a potentially infinite number of buyers, who each would be willing to trade for $1.99. Why is it that the model assumes that sellers score all of the surplus of the trade? The question is especially poignant for the more theoretical theorists, who are happy to think not of buying widgets with cash, but of buying cash with widgets. In the reversed situation, the names in the sides of the market are reversed, but nothing else has changed.

[The standard solution is to have heterogeneous buyers and sellers, some of whom are scoring surplus and some of whom aren't. But then, there seems to be a mantra throughout the literature that profits go to zero, but no corresponding mantra that consumer surplus also goes to zero. You can delay the creation of asymmetry arbitrarily far through undergraduate micro, but it eventually turns up.]

Whatever the reasoning, the assumption that the buyers get all the surplus has immediate political implications, because it means that the seller is barely scraping by. Raise taxes, impose more laws, make any sort of costly intervention and the price will immediately rise by exactly the cost of the intervention, because the price is exactly the cost of production, no more. But with an infinite number of buyers and only one seller, the story would be that there's lots of fat in the price, and the seller is indeed making profits and won't go out of business if forced to comply with environmental regulations. The practical effect of the assumption that profits go to zero for all suppliers (and it is just an assumption in the end) is that companies get to whine.

As a matter of fact, the vast majority of successful companies actually do make a profit. That means that the widget is not getting sold for exactly a dollar, but somewhere between a dollar and two.

There's a standard little exercise they make you do in undergrad econ class, the right glove/left glove problem, where you calculate the prices in equilibrium for right gloves and left gloves when there are R mathend000# right glove suppliers and L mathend000# left glove suppliers, and people of course want an equal number of both. You do the math, and if R < L mathend000# then the price of left gloves goes to zero, and L < R mathend000# then the price of right gloves goes to zero. It all seems so horribly lopsided, but the fact is that with no specific means of describing the bargaining process, with no specification of exactly where the surplus goes, then the side in the minority will generally gain all the surplus.

Now consider labor. As anyone who has ever been on the market knows, there are few openings and many people to fill them. The scarcity is on the hiring side, and (barring the exceptions and caveats), the surplus will lean toward the hiring side as well. That is, the surplus is going toward the company. There are more people than companies, and that ain't gonna change any time soon.

And so, point number one about policy: the side which is in the minority probably has no right to whine. That is usually the capital side of the capital-labor team.

Meanwhile, the laborers are in quite a bind, because their prices can be driven arbitrarily low. The solution to the asymmetry on the labor side of things is to make labor more scarce: take a million workers and turn them into one unit for bargaining purposes--that is, unionize. You can find a hundred cute stories about unions have set arbitrary dumb rules, or historical corruption in these organizations, or a million other details great and small that unions messed up. But they solve a fundamental problem which really has no other solution: the bargaining process between labor and employer is fundamentally asymmetric and so one expects that most of the surplus will go to the employer. The only solution is to kill most of the workers (the black plague solution) or to unionize.

The threat point

Again, capital wins out over labor on this one. If we're on the job market, we probably need that job to buy food; if we're on the capital market, we're probably looking for maximum profit. Now say you're the government and you're deciding who you want to tax: the capitalists will walk away if the tax rate is too high; the laborers will just grumble at higher taxes and keep chugging on. And so, capital gains are taxed at a lower rate than labor. [tech speak: the elasticity of capital provision is higher than the elasticity of labor provision, so the distortionary effects of taxes will be greater for capital.]

I would love to see the unions of the world protest when capital taxes are lowered and therefore labor bears a higher burden. I would love to see the Teamsters go on strike until the President signs through a rise in the capital gains tax and an according lowering of the general income or social security tax. But I guess that'll never happen, and labor has no threat point of any sort.

Another little detail of the law which gives capital an edge over labor is that there are very few restrictions on the movement of capital across borders, but very strong restrictions on immigration. A company can readily say `Lower my taxes or I'll move to France' because France will be happy to take the company in; a laborer in the same position would need to spend up to a decade dealing with paperwork before moving. Wages may be higher for your work in Windsor or Vancouver than in Detroit or Portland, but you're not invited.

But, you're thinking, all the companies move to Mexico, and I don't really want to move there myself. First, parts of Mexico are rather nice. Second, you should still care because laborers and companies in Mexico are in the midst of the same negotiations. Why is it so easy for companies to cut costs by moving to Mexico? Because Mexican workers can't leave; trapped, their wages can be driven to an arbitrarily low level. That makes it easy for U.S. companies to threaten to leave, which lowers the taxes on U.S. companies and thus raises the burdens on U.S. workers. Worried that your wages will fall if an imaginary flood of immigrants should cross the border? Your wages are already falling because capital can flood across the border to where the labor is. There are loads of other considerations, but generally, restricting labor's movement causes labor to suffer.

To summarize all this: there is always some surplus to any fair trade, and there is no economic law about how that surplus is divided. One general rule of thumb is that the less populous side of the market will generally get more of the surplus--that means employers, not laborers. Another general rule is that the side which can walk away from the trade can get more of the surplus--that means employers, not laborers. These facts about the world have immediate implications to anyone who thinks that workers should be getting more of the surplus from selling their labor. First, unions are a good thing, and laws which fetter their bargaining ability should be stricken. Second, allowing immigration is good, because letting capital move freely but tying labor down only limits the bargaining ability of the labor side. The natural state of things is already an asymmetric bargaining position; why make it more asymmetric by passing laws that restrict labor but not capital?

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