A great piece of advice for living is to leave money on the table: don’t try to get the maximum benefit from every deal leaving as little as possible for the party on the other side of the transaction. So when you sell a house, buy a house, negotiate a job offer as either the employer or the employee, don’t try to wring every penny out of the deal for yourself. Leave something for the person on the other side. This doesn’t mean be a sucker; it means don’t be grasping — don’t be the kind of person who always looks for not just an edge, but the maximum edge every time.
The real insight from this strategy is in the last sentence — “don’t be the kind of person.” It’s not just about this transaction and how the gains from the deal might be divided up, it’s about how you’re perceived by others and who you really are. A person who relentlessly tries to exploit others for maximum gain is unpleasant and struggles to find people to interact with. That’s no fun. And many of us just don’t want to think of ourselves as that kind of person. Plus you’ll remember the time you made a killing and forget the time someone walked away just to spite you because you got too greedy.
In the modern world, most of our economic transactions don’t leave room for these kinds of tradeoffs. Uber offers me a price during rush hour that is 50% higher than usual. I take it or leave it. There’s no room for me to make a counter-offer. Almonds are really expensive these days. They may be cheaper at Costco than they are at my local grocery but I can’t tell my grocery that if they lower their price of almonds by 15% I’ll buy theirs instead of Costco’s. Threatening to go to Costco moves them not at all.
All my online shopping is take it or leave it. Amazon and other online retailers I use frequently— airlines, Zappos, REI — post their prices and I am free to purchase or walk away. There’s no negotiation. In my almost 40 years of working at universities, salary increases are rarely negotiated. I am usually offered a raise which I accept. If I want more than that, I could make a fuss but I don’t know how successful it would be. Most academics get big raises only when they have a better paying offer from outside. A new job opportunity does give an opportunity for negotiation, but most of the time, there is little role for any kind of strategic skill in determining what I am paid.
There are a few cases in daily life where negotiation comes into play. I’ve had roofers who claimed that they needed more money because of unexpected challenges of the job. My car dealer dramatically reduced the price of a repair merely because after he told me the first price, I told him I would shop around and get back to him. (Even so, the reduction was insufficient. I ended up at Meineke).
We get our house cleaned once a week. The head of the crew has never asked for a raise. But while they have worked for us we have raised their pay almost 50%, partly because of the principle I opened this essay with and partly because we sense the wages of cleaning crews are higher now than when we first hired them. The other major place in my life where there is play in the price I pay is when I’m traveling and shopping for a unique piece of pottery or jewelry or clothing especially in a foreign country. There, it is understood that I will offer less than the price that’s marked.
Modern economies have much less scope for negotiation because negotiation is costly. Posting take-it-or-leave-it prices or wages are typically the result of large organizations with numerous customers or employees. Standardization of prices and wages avoids the costs of haggling. Has that been good for consumers and workers or has it been good for sellers and employers? Or is it good for both of them?
Or to ask the more fundamental question, what protects us as consumers and employees from exploitation? In particular, with unions being an increasingly unimportant part of the American labor market — fewer than 7% of private sector wage and salary workers were unionized in 2016 — what, if anything, protects workers from exploitation?
One answer to these questions comes from a new online textbook that is getting a lot of attention. Unit 4 of the textbook, Social Interactions, introduces game theory, a way of modeling strategic interactions. Section 10 looks at “dividing the pie” and as an example of way the gains from a transaction might be split, introduces the Ultimatum Game. Two players are going to share a pie, but one player, the Proposer, has more power than the other, the Responder:
The Proposer is provisionally given an amount of money, say $100, by the experimenter, and instructed to offer the Responder part of it. Any split is permitted, including keeping it all, or giving it all away. We will call this amount the ‘pie’ because the point of the experiment is how it will be divided up.
It’s a take-it-or leave-it offer. If the Responder rejects it, both players get zero.
The authors invite the reader to consider the strategic issues raise by these rules. If you are the Proposer might think to offer the Responder $1 while keeping $99 for yourself. Do that and you risk a Responder rejecting the offer and getting nothing. A proposer offering $50 is likely to get an acceptance but there is the temptation to do better than that — you’ll still probably get an acceptance if you offer 60–40 or even 70–30.
In Unit 5, the textbook applies the Ultimatum Game to the labor market and introduces the idea of “bargaining power.”
The rules of the ultimatum game determine the ability that the players have to obtain a high payoff — the extent of their advantage when dividing the pie — which is a form of power called bargaining power. The power to make a take-it-or-leave-it offer gives the Proposer more bargaining power than the Responder, and usually results in the Proposer getting more than half of the pie. Still, the Proposer’s bargaining power is limited because the Responder has the power to refuse. If there are two Responders, the power to refuse is weaker, so the Proposer’s bargaining power is increased.
The authors want to apply this structure to the real world:
In experiments the assignment of the role Proposer or Responder, and hence the assignment of bargaining power, is usually done by chance. In real economies, the assignment of power is definitely not random.
In the labour market, the power to set the terms of the exchange typically lies with those who own the factory or business: they are the ones proposing the wage and other terms of employment. Those seeking employment are like Responders, and since usually more than one person is applying for the same job, their bargaining power may be low, just as in the ultimatum game with more than one Responder. Also, because the place of employment is the employer’s private property, the employer may be able to exclude the worker by firing her unless her work is up to the specifications of the employer.
In my view of the world, “the power to set the terms of the exchange” is often an illusion. Yes, the employer offers a particular wage for a job it is hoping to fill. Yes, the bank offers a particular interest rate for deposits. Yes, the grocery tells you what they want to charge for apples and yes, it’s take it or leave it.
But none of these true statements imply power, in and of themselves. You can see it when you have the power to set a price yourself. If you want to sell your house, you have the power to charge whatever you want. Or at least it appears that way. But set a price too high and your house will sit on the market unsold for month after month. Set a price too low and your house will sell in an afternoon and while you may be relieved that the house is sold, you may realize that you probably could have charged more and still sold the house fairly quickly. When you pick the price of your house, you look at the “comparables” — houses in similar school districts and similar square footage and number of bedrooms and bathrooms.
Some things are hard to compare. You may be convinced that the new kitchen you put in raises the market value of your house by an extra $100K. You might convince yourself it only takes one person to fall in love with the color scheme of that kitchen or the tiles you chose or the way it makes the traffic flow work in the house for a party. But even that one person who loves your kitchen has choices. Other houses. Yes, those other houses might not have as nice a kitchen. But it’s probable that no one loves your kitchen enough to pay a $100K premium. Your beautiful kitchen may give you a little bargaining power. But it is tempered by the fact that there is more than one house that is pleasant, even if those other choices fall short in the kitchen comparison.
Wal-Mart doesn’t offer what you might consider low wages because Wal-Mart is powerful. They offer low wages because the people they seek to hire have skills that alas, are only worth that wage. It’s the same reason Wal-Mart pays more in the United States than in Mexico. It’s not because of the minimum wage laws here or that the US has more unions or because of the “bargaining power” of US workers relative to Mexican workers or because lots of people apply for jobs in Mexico than in the United States or because more than one person applies for any one job. It’s because workers in the US generally have more choices and better choices than workers in Mexico.
It’s hard to believe but Wal-Mart would love to pay even less. They don’t because they can’t pay less and still attract enough workers to do the jobs they want to fill with the quality of people they’re looking to hire.
Let’s go back to my cleaning lady. I would seem to have all the power to strike a tough bargain. She has no formal education. She speaks English imperfectly and some of her helpers speak it not at all. She’s one of dozens of people I could choose from who are eager to clean my house. No union represents her. Yet I pay her about more than double the Maryland minimum wage of $9.25. Her helpers, who bear none of the out-of-pocket costs of the operation (cleaning supplies, equipment, gas and depreciation on the car they travel in), make about $12-$13 per hour. Why do I pay them more than the minimum wage? It’s not because I’m a nice guy. It’s because if I offer too much less, the crew won’t show up. They have alternatives — for starters, other houses they can clean.
Game theory, negotiating skill and bargaining power are not the right way to think about what determines what people earn in the modern economy in 2018.
On Labor Day of this year, Larry Summers decried the disappointing growth in wages during the recovery of the economy from the Great Recession. What’s the explanation? While conceding “economists don’t have complete answers” Summers writes:
But I suspect the most important factor is that employers have gained bargaining power over wages while workers have lost it. Technology has given some employers — depending on the type of work involved — more scope for replacing American workers with foreign workers (think outsourcing) or with automation (think boarding-pass kiosks at airports) or by drawing on the gig economy (think Uber drivers). So their leverage to hold down wages has increased.
I don’t think this is the right way to think about what’s going on. It’s not bargaining power that has changed. Employers don’t have more or less leverage over workers like an employer in a company town. It’s just that the demand for low-skill workers is lower. When demand falls, wages fall. It has nothing to do with bargaining power or leverage. The market rate has changed. Of course the labor market isn’t perfectly competitive like some Econ 101 blackboard example. But market forces matter. When the demand for a particular kind of skills fall, workers with those skills are going to make less.
The “bargaining power” explanation implies that workers who once got a good deal are now getting a raw one because employers can squeeze more out of workers. I don’t think that’s the source of the problem. The problem, as Summers points out without intending to, is that workers are in competition not with rapacious employers but with emotionless robots. The usual solution of raising the minimum wage just makes those robots even more attractive.
Another purported cause of disappointing wage growth is unions. But unionization as a proportion of the labor force has been falling pretty steadily since 1950 or so. That’s due to a change in the nature of work in America. Unions don’t fit the labor force of 2017 where jobs are often complex and less routine than an assembly line. Unions are very good at keeping government workers paid well and pensioned well in a sector of the economy that is essentially free of competition. But slow and steady demise of unions is not the source of the problem and it’s hard to imagine a world where they’re coming back in any significant way.
The long-run answer is better schools that help workers acquire the skills that make them more valuable. Our political system has failed three generations of inner-city children. Their economic challenges have nothing to do with bargaining power but the growing gap between the skills that are rewarded handsomely in 2017 and the skills students are provided in mediocre public schools. Staying in school also seems to help students earn higher wages when they graduate.
he short-run answer is, as the saying goes, luggage. Poor unskilled workers in the poorest countries of the world who find their way to the United States legally or illegally get a big increase in standard of living somehow overcoming the alleged bargaining power of employers here. Many of the lower-earning workers in America could make more if it was easier to move. Larry Summers agrees, though he blames the problem on a tightening of mortgage credit that makes housing harder to find. I blame ever-tighter zoning restrictions that make it harder to increase the supply of apartments in America’s most productive cities.
So what protects us from exploitation? In the story I’ve outlined above, the answer isn’t the minimum wage. Or unions. It’s competition. The market process encourages people to treat other people well because we have choices. Bargaining power, even in a take-it-or-leave it offer, is not decisive or even important when workers have alternatives.
And yet.
How do those of us who believe in the power of competition understand the flood of stories of sexual harassment in Hollywood and elsewhere summarized by #MeToo?
Harvey Weinstein had power despite the fact that he was one of many gatekeepers in the movie industry. You’d think that his grossness would lead women to ignore him or call him out sooner than they did. But it didn’t. Women feared, correctly, that he could end their careers. Was his power because it’s a small tight-knit industry — there are just not that many gatekeepers? Or was his power coming from the fact that most of those gatekeepers are not all that different?
Gary Becker published The Economics of Discrimination in 1957. While he understood the power of competition, he also understood that competition would not eliminate discrimination if a taste for discrimination was sufficiently widespread and large enough to offset the financial returns from being open-minded. (And people who claim that Becker thought competition would eliminate discrimination haven’t read the book or they’ve conveniently forgotten its contents.) If every Hollywood exec is a pig and willing to sacrifice significant money to indulge in piggishness, it gets a lot of harder to rely on competition to protect actors and actresses from exploitation. So you don’t get all the best talent? So you lose talent to other less exploitive competitors? It can still be worth it for abusive, selfish, cruel executives.
The reality of sexual abuse in the movie industry and elsewhere raises uncomfortable questions for those of us who are classical liberals. We prefer decentralized bottom-up solutions to those decreed from the top down. We believe in freedom, personal responsibility, and self-regulation via competition and norms of trust and virtue. We tend to see people as agents with the freedom to choose. Exit and free association play an important role in creating civilization. We are skeptical of the left’s focus on power being at the center of all relationships and the left’s focus on the world as a struggle between the oppressor and the oppressed.
When free-market types like myself hear about a worker who is made uncomfortable by inappropriate language or inappropriate physical contact on the job, our usual response is: quit. You don’t have to work for a crude, or worse — abusive boss. And of course, you are free to quit, and many do. But what is clear from the MeToo moment we’re in is that many people couldn’t quit. Or at least they felt they couldn’t. They stayed in abusive work relationships. Women privately shared information about who to stay away from and who not to be left alone with. But they often stayed on the job and endured humiliation, gross discomfort and sometimes, much worse.
There is an important distinction between verbal abuse and physical violation. There is also an important distinction between a misunderstood phrase or a flirtatious remark that is met with disapproval and relentless sexual innuendo that is designed to manipulate an employee. People make mistakes. They are misunderstood. But too many of the accounts we’ve read and the resignations or firing that result are way beyond mistakes or misunderstanding.
That Hollywood executives exploit women eager to succeed in the business is not a new story. What is new is how egregious the exploitation is and how it extends beyond Hollywood to other industries. And of course, we are not hearing every story. There is still shame and humiliation that keeps victims silent.
Arnold Kling’s deeply insightful book, The Three Languages of Politics lays out the different lenses that liberals, conservatives, and libertarians use to understand the world. Liberals see the world as a struggle between the oppressors and the oppressed and side with the oppressed. Conservatives see the world as a struggle between barbarism and civilization and side with civilization. Libertarians see the world as a struggle between coercion and freedom and side with freedom. Followers of each ideology struggle to understand the lens of the others. Kling argues that this inability to see the world through the lens of people who disagree with us is why political dialogue is often so bitter and unproductive — we’re talking about different things.
In an essay on Kling you can find here, I argue that with each lens Kling identifies, there’s a blind spot. Liberals can be so convinced that the oppressed are so victimized, liberals can assume that poor people, for example, have no choice or agency. They become objects to be pitied rather than human beings who can affect their own destiny. Conservatives are so worried about the retreat of civilization that they can falsely stereotype a group like immigrants, many of whom work multiple jobs to help their family and embody the civilized virtues conservatives respect. Libertarians can be so convinced of the power of freedom they forget that in some situations, our freedoms may be constrained by forces that are not from the State or from the top down — culture, circumstance, the way we were raised. Many of us have more agency than others. The MeToo moment we are in right now is a reminder that standing up to power can be a lot harder than some of us imagine. And in these situations of one-on-one interactions, bargaining power, or at least some kind of power, seems relevant.
How do I reconcile these two visions of the labor market — the one that suggests that power is diffused and less important than we might think in the first part of this essay, and the one that suggests power is easily abused, in the second part of this essay? And what are the implications of these two visions for public policy? And can those implications be reconciled?
These aren’t easy questions to answer. One answer is that there isn’t an answer — that there isn’t a simple single vision of the labor market that describes what goes on. How power works, how market forces affect us, what we are paid, and how we experience the workplace day-to-day, is complicated. It depends on our skills, the industry we find ourselves in, and the personal traits we bring to the job that go way beyond our formal abilities.
My other thought on these complexities is that are important differences between what we are paid and the myriad aspects of a job that go beyond pay — how we are treated, what we learn, whether we are mentored or abused, whether our personal circumstances are taken into account when we face challenges and so on.
Alternatives are everything. If you don’t have alternatives, the market will punish you, not the expediency or grasping nature of your boss or employer. But it is also true that if you don’t have many alternatives or if you think you don’t, you are more vulnerable, especially in the day-to-day interactions with a nasty boss.
We care how much we are paid but the environment on the job matters a great deal. The intangible interactions we have with fellow workers and with our bosses and employees have more leeway in them for abuse on the one hand and kindness on the other. A lousy boss who fails to mentor and who makes employees uncomfortable may be able to stay in his or her job simply because these intangible aspects of performance are hard to measure or because no one is paying close enough attention. Normally, high turnover would suggest a bad boss. But if workers are uneasy about quitting for a variety of reasons, poor managers can stay in their jobs more easily.
Part of what is happening is related to the story I told in the first part of this essay. Wages, salaries, and benefits are transparent. You take the package or you don’t. But how you get treated day-to-day on the job is more complicated.
Corporate culture matters a lot and as economists we don’t have a lot to say about it. Maybe we ought to pay more attention to it and think about ways that corporate culture responds to competitive pressure. How would you expect being highly profitable to affect that culture? Do firms with thinner margins pay less but do a better job on the intangibles?
Finally, there is a question of what policy responses are good or bad for workers. I have long argued that one of the biggest problems of the minimum wage is that it only looks at one aspect of the employer/employee relationship — pay. Pay is really important. But others aspects matter, too.
A binding minimum wage (a wage above what the market would otherwise set) increases the number of people eager to work and makes it harder for workers to find a job. That discourages quitting your job — if you do you will find yourself competing with a lot more people than you otherwise would be competing with to get one of the relatively attractive minimum wage job. This means that all of the non-monetary aspects of the job — the mentoring, kindness, understanding of your personal situation on a Tuesday when your kid is sick, basic human decency — are less likely to be supplied to minimum wage workers. Lousy managers find it easier to attract employees and keep them under a minimum wage. For this (and other reasons) I think a minimum wage is a lousy way to improve the lives of workers who already have limited alternatives.
Market forces, which is another way to summarize the range of alternatives we have available, affect how we are treated on the job. Economists who tend to see policy intervention as benign, should remember this. But market forces do not capture fully what happens on the ground in the day-to-day interactions in the workplace. Those of us who are skeptical of intervention should recognize the limits of competition in protecting us from exploitation.