DP17302 Monopsony Makes Firms not only Small but also Unproductive: Why East Germany has not Converged

Author(s): Rüdiger Bachmann, Christian Bayer, Heiko Stüber, Felix Wellschmied
Publication Date: May 2022
Keyword(s): aggregate productivity, customer capital, monopolistic competition, Monopsony Power, plant heterogeneity, Size distortions, size-wage curve, Unions
JEL(s): E20, E23, E24, J20, J42, J50
Programme Areas: Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=17302

When employers face a trade-off between growing large and paying low wages---that is, when they have monopsony power---some productive employers will decide to acquire fewer customers, forgo sales, and remain small. These decisions have adverse consequences for aggregate labor productivity. Using high-quality administrative data from Germany, we document that East German plants (compared to West German ones) face a steeper size-wage curve, invest less into marketing, and remain smaller. A model with labor market monopsony, product market power, and customer acquisition matching these features of the data predicts 10 percent lower aggregate labor productivity in East Germany.