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 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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