Here's an essay I wrote. It's mostly sketching out the general case without going into case studies. I realize people like to bring things down to reality but it didn't feel right for this essay.
Arthur has an oil well. Caleb has the skill to refine the oil. Without the oil the skill is useless. Without the skill to refine the oil the oil is useless. How do they share the profits that come from selling the refined oil? How do they negotiate the split of the profits?
One might imagine that Arthur could choose from many oil engineers and select the one that will give him the best deal, and Caleb could find the oil well owner that will give him the best deal, and supply and demand would meet in the middle through ordinary market forces. In practice this isn’t always how things go. Sometimes one side doesn’t have any other potential partners. Sometimes, for one reason or another, neither side does. If there’s only one seller and one buyer, that’s known as a bilateral monopoly. In the case of the oil well it’s less a matter of buyers and sellers and more about two business partners who can’t profit without the other.
In such cases, negotiation turns into a game of chicken. If Arthur offers Caleb a split that Caleb thinks is unfair, Caleb can refuse it, in which case the oil stays in the ground and neither side gets paid. Likewise for an unappealing deal that Caleb offers to Arthur. If one side wants 95% of the profit, the other side could reject the deal, even if it means no profit for either of them. That’s not irrational, it’s just the only way to exercise leverage in such a situation.
So far so obvious. But here’s the thing that I want to call attention to: in a simplified model, the deal that will go through is one where the wealthier business partner gets a larger cut of the profits. In a market with only one buyer and one seller, the side with the highest willingness to cancel the deal has the most leverage, and the richer side (theoretically) needs the money less. Horribly ugly, but also utterly reasonable. In many cases we may wish it were otherwise, but if the poorer business partner cancels the deal too often out of indignation and pride that’s not so great either.
It might seem like the situation I described with only one buyer and one seller is unlikely to occur, but consider the situation in Venezuela under Hugo Chavez: Chavez couldn’t fire all the domestic oil engineers and replace them without greatly hampering oil production and disrupting the workings of the entire country, and the oil engineers couldn’t go work somewhere else without uprooting their lives and going to an entirely different country. Venezuela didn’t have a monopoly on oil, and the oil engineers didn’t have a monopsony on oil engineering, but the costs for switching partners were high enough that somewhat similar effects were in play, I think.
Mood board:
The national pride of poorer countries as a recurring factor in geopolitics
Oil negotiations between Iran and Britain in the 1950s
Hugo Chavez firing all the oil engineers in Venezuela
Hollywood Strikes
The likelihood that both sides will think that what they bring to the table in the deal is the key ingredient in the process and therefore more valuable.
Additional thought:
What would it look like if the richer side needed the money more? Could that ever happen? Maybe there could be situations where the richer party has “farther to fall” than the poorer party. For instance, if the richer side of the equation has a lot of valuable businesses that need capital injections in order to stay afloat, and the poorer side of the equation can just continue with a meager but stable lifestyle.
https://absenceofweather.substack.com/p/fair-and-unfair-in-bilateral-monopolies
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Notes -
I've gone through two negotiations recently with exactly this dynamic. Recently being a bit of a stretch.
My company was a startup, with me being the second employee. I brought technical skills to the table, but had virtually no sales connections. I required a salary, while the CEO had cashed out part of his 401(k) to pay for me and others the first year. I was the only high-quality tech person that my boss knew in our market who wasn't bound by a non-compete. He had the upper hand in these negotiations (the cap table agrees!)
I recently flipped a car with a relative. They didn't have the courage or knowledge to broker the deal, and I didn't have the geographic location to physically do the work of acquiring, re-titling, and selling the car. They were the only person there I knew well enough to successfully get it done. It definitely felt like our difference in capital gave me far more leverage.
Both of these aren't pure bilateral monopolies, but they were close enough that it felt very similar.
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The VC bubble of 2021 or VC in general seems to be the employee has more leverage situation. The key idea is you just need more money (from an old capital rich society) chasing too few good ideas/opportunities.
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I do think you underestimate the effect in your last paragraph. Both from my own impressions on dealmaking between employers and employees and basic investment vs return thinking, the employee has significant leverage in that if the company fails, he can just go to another with at most a small pay cut, while the business owner will lose everything he has build up so far. It seems to me that being rich in general gives you more leverage, but being more invested in the thing under discussion gives you less leverage. So everything else being equal, an independently rich employee has the most leverage, while a small-scale business owner with no other large investments has the least leverage.
Good point. That's not really a bilateral monopoly, but part of the essay is about exploring how the dynamics of bilateral monopolies are similar to some extent to less monopolistic exchanges.
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And the extreme case (and also the most common one) is a publicly-traded company where management will keep their jobs under Chapter 11, the Board are mostly retired executives of other companies, and the shareholders are diversified. Apart from the tangible assets at stake (such as a car factory being idled during a strike), the people on the opposite side of the table to the union have nothing invested.
Private equity has a reputation for being even more ruthless than publicly-traded companies, possibly because the owners are maximally disinvested through financial leverage.
Where do you have the information from that this is the most common case? Afaik, the stats are pretty clear that the majority of companies aren't publicly traded, even in the US it's only something like 10%. If I go by my - admittedly very biased - german sample, founder=owner=CEO is quite common for smaller companies, and afaik the stats here are even worse in percentage terms.
I meant most common case in terms of most workers, not most firms. (Publicly traded companies tend to be large). This study says that US listed companies employ 23% of total non-farm payrolls, down from 31% in 1984 when the time series they were using started. US employment by foreign listed companies adds another few points to this.
These numbers are lower than I thought, so I need to retract "most".
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In a pure, mathematically perfect, game theory bilateral monopoly, any distribution is a Nash Equilibrium, making the actual distribution arbitrary and impossible to deduce logically. Any offer someone makes and commits to would be irrational to refuse, but any counter-offer is similarly irrational to refuse, although I suppose if you modify the game with some sort of negotiation system attached and maybe some semi-rational actors you could come up with some sort of converging equilibrium.
In the real world, nothing is a perfect bilateral monopoly isolated from other economics, in which case the asymmetry of the breaking of this monopoly is likely to have a very strong impact on the negotiation. Labor pretty much always has value, if nothing else than the fact that sitting around relaxing is typically more enjoyable than working (not literally always though), and there are plenty of other jobs someone could take. So if there's a resource A that is completely worthless without skill B, and person B has skill C that's useless without resource A, you still don't have a perfect bilateral monopoly because person B could go do something else even if it doesn't use that skill. This gives person B an advantage in negotiations. Or maybe person B can extract value from A with 99% efficiency and some random Joe off the street can extract value with 5% efficiency. That gives person A an advantage. Unless the bilateral monopoly is truly perfect, both the resource and the skill/labor are completely useless without each other, the imperfections in the monopoly are going to provide pressure on the negotiating price. Internal factors of the people such as their wealth and utility functions may also play a role, as you point out, but I think the asymmetries in the monopoly are going to be a bigger factor.
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I enjoyed industrial organization (the economic term for how markets form). The two cases that come to mind are an oil well and refinery with a pipeline connecting them. There are alternatives but generally the vastly lower transportation costs mean the well is only selling to the refinery and the refinery is only buying from the well. Maybe very heavy or sour oil works too (refineries need special refining methods to refine very heavy oil), which means at extreme ends of the scale both the refineries and wells are stuck with the other.
The other case this reminds me of are high draft picks negotiating their first contract. The draft often restricts players to their drafting team for some period of time. Absent players being good enough to play multiple sports professionally (Bo Jackson was the most recent I can recall) that means they are a monopolistic seller of their talents to a monopsonist buyer. Only really works if they're uniquely talented (like Bo Jackson) otherwise another talented player reduces the seller's barganing power considerably.
I think it's interesting that today nearly all US professional sports leauges have a roughly 45-60% split of revenues for the players.
It’s also interesting all sports leagues have unrestricted free agent and roughly the median player age. And restricts the pay of younger players.
Basically bribing the 51% oldest person with UFA status to get the CBA approved.
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Imagine that Caleb is not one person but the "Caleb Union" which contains ten people but otherwise has exactly the same skills, together, as Caleb does in the original scenario. The union is so strong so you can't break them up or hire them partially.
Given what you think a fair distribution of profits between Arthur and Caleb is, how should profits be distributed between Arthur and the Caleb Union?
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Company and a critically needed employee? (strictly speaking they need relevant expertise, not money). If entire factory is stopped and you accrue millions in damage per day then emergency hiring of froggozlle foobar twitcher is going to be expedited and outrageous wage is going to be spend if needed. I guess that producer of train is holding you hostage or something then similar may apply (one such case was kind-of-public recently, though no idea how much they got paid - in this kind hackers could consider playing with train to be part of payment :) ). My kind-of-dream is to be hireable for job where I am paid several millions to tweak some toggles for few minutes based on decades of my experience.
On more replicable scale it sort of happens with programmers. There is a reason why programmers are being better paid than say cleaners.
That's not due to bilateral monopolies though. That's just normal supply and demand. Bilateral monopolies would be more like United Autoworkers or other heavily unionized jobs.
Given job market in some cases you end with "do you want me or noone?"
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With programmers you can get some degree of bilateral monopoly power, where a long-time employee of a firm has a lot of firm-specific knowledge, which is very valuable to the firm but not to anyone else. This the programmer has something unique to offer the firm, and the firm is the only one willing to pay for it.
This is probably more likely to happen at non-tech firms, as tech firms are better at making sure that no crucial software is exclusively maintained by one person.
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In theory, you could have a rich entrepreneur who doesn't have the skills to live off the land on his own, and a poor worker who does. If they don't make a deal, the laborer has his garden and chickens and the oil baron starves.
In practice, I don't recall ever hearing of such cases.
"Has further to fall" is a misnomer, what matters more is "can fall lower". Going down from billionaire to worker class is a different kind of falling than falling from worker class to penniless.
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Sounds a lot like the situation with many unions. If you are the owner of a business, depending on the local laws the people who happen to work for you get a free monopoly on your labor supply if they form a union. If it's a capital-intensive business then the owner has more to lose.
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First of all, thanks for creating a new thread instead of posting to the Culture War thread. I think it would be great if more people did that.
Secondly, I am sure there are a mountain of unread economics PHD theses about just this topic.
Here is my own initial reaction:
How do you divide profits fairly when there are N contributors whose contributions are necessary, but not sufficient, to create the profit? Do you divide the pie evenly by N? No, I don't think so. Kevin Durant couldn't have won the MVP award if his mom hadn't given birth to him. But I don't think his mom deserves half his salary.
Looking at opportunity cost is a fair way to divide the profits. Let's say you have only one option, but I have lots of options. If you want me to join your project, pay me more. This is why software engineers get paid more than HR reps. Software engineers have talents they can shop around. HR reps don't.
You are framing this opportunity costs in terms of wealth/poverty, but it could just as easily be framed in terms of skill/lack of skill.
The game theory solution to the general problem of arbitrary possible coalitions with different "profit" is the Shapley value
(The page even includes an example of a capital owner and m workers).
In the simple case where there are two people, Alice and Bob, who can make A or B by themselves (respectively), or $100 together, the payoffs are simply:
I think it's theoretically defensible to claim that parents ought (in an economic / game theoretic sense) receive a significant fraction for the value their kids provide society. It definitely screams against most people's moral intuitions though.
Does it? That is an interesting question to me. Based on my social circle, the norm "people who are unusually financially successful compared to their parent should give something back, unless those parents were abusive" is a supermajority view even among white people. The moral intuition against making this a legal entitlement is strong*, but the intuition in question is "The State should not intervene in families" not "adult children should not support parents." AITA normally rules in favour of the kids in "am I obliged to give my parents money" cases, but the cases that come up are normally abusive parents or absurdly entitled South Asians - the basic case of a rich kid who doesn't want to help a poor parent doesn't seem to come up.
In the Anglosphere, the whole thing is of course complicated by Boomer housing wealth, which means that an adult child making a top 1% income can have a lower material standard of living than their middle-class parents who bought a house in the right place at the right time (particularly if they have children of their own), but still read as rich.
* Even in Asian countries with a strong norm of supporting your parents, the legal requirement is restricted to "children should provide the bare minimum support to stop their parents being a burden on the taxpayer."
The claim "children doing far better than their parents, financially, should give some small fraction to their parents" is miles away from the claim that most parents are entitled to a significant share of their children's income.
The controversial claim here isn't whether somebody making $500k should give $20k/year to his parents, who are making $40k each. It's that the kid making $80k/year owes his parents, (who are also making $80k/year), $10k/year for 10 years, because he owes a significant fraction of his success to 18+ years of his parents' labor.
I think it goes against the common morality because:
(1) Old people aren't supposed to need as much money as their children, they typically don't need to pay their mortgage anymore and don't have children to take care of. A couple of pensioners with 80k$/year is a lot richer than a couple of middle age parents with the same revenue.
(2) When the parents die their money will typically be split evenly and it means that the richest sibling is paying for the others
(3) It's not easy to know what share of the success of the child is a result of the parents' labor and what is the result of the child's own merit. If the children owe something to their parents, it is probably proportional to their average income (because the parents' labor should have been shared evenly among the children and thus any variation between them is supposed to depend only on the individual labor of each child)
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I think the “controversial” claim is not in fact controversial in societies without government tax-and-transfer programmes which take $10k from the typical worker and give $10k to the typical pensioner.
The West socialised the obligation to support aging parents. We didn’t abolish it.
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HR reps have talents they can shop around, too. Lots of companies have HR departments, probably more than have in-house software departments. But the people who can do those jobs are more abundant, relative to supply, than software engineers.
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Prices and wages only equal opportunity cost in a competitive market. They still matter in the monopolistic setting, but the whole point is that any distribution of rents that is above everyone's opportunity cost is economically efficient and a possible equilibrium.
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