Labour market power is an important source of market distortions in modern economies, as it typically allows firms to pay a wage below the marginal product of labour – the so-called wage markdown. Di Mauro et al. (2023) show that for large European firms, market power is mostly driven by the labour market rather than the product market. This matters for welfare. Berger et al. (2022) estimate that labour market power reduces output by a fifth and welfare by 8% relative to the efficient allocation. By depressing employment and wages, market power can also reduce the labour share of national output (Naidu et al. 2018, Brooks et al. 2021) – a key measure of inequality that has been declining in most of the world.
Understanding the determinants of labour market power is thus crucial to address its potentially distortionary effects. The literature has posited a positive relation between labour market concentration and employers’ market power, which is consistent with wages being lower in more concentrated labour markets (Amodio et al. 2022, Benmelech et al. 2022). On the basis of this intuitive relationship, some authors have proposed to extend antitrust approaches used to regulate product markets to regulate labour markets (Naidu et al. 2018, Marinescu et al. 2021). However, systematic evidence of a causal relation between market concentration and labour market power remains elusive.
Does product market concentration affect labour market power?
In a recent paper (Calì and Presidente 2023), we start to fill this gap by studying how changes in regulatory barriers to entry affect firms’ labour market power. To guide the empirical analysis, we build a simple model in which a finite number of employers compete strategically to attract workers. Deregulating product markets lowers entry costs and increases the equilibrium number of firms. This in turn raises the number of alternative employment opportunities for workers. The resulting loss of employers’ labour market power reduces their ability to impose a positive wage markdown.
We test our theory empirically using data on Indonesian manufacturing, where our estimates suggest that over 95% of plants exert some degree of labour market power. The empirical test requires identifying some plausibly exogenous source of variation in entry costs. To that end, we collect granular data on investment restrictions across 346 narrowly defined manufacturing product-markets included in two consecutive issues (May 2008 and December 2010) of Indonesia’s Negative Investment List (NIL), or Daftar Negatif Investasi. That is a Presidential regulation which detailed the conditions that new investors had to fulfill to register a company in any Indonesian sector.
After addressing concerns of potential endogeneity of changes to the NIL and product market trends, we exploit changes in restrictions across product markets in 2008-2014 (see a sample in Figure 1) to estimate the causal impact of product market regulation on wage markdowns.
Figure 1 Share of regulated product markets in each revision of the NIL, selected sectors
Our markdown estimation relies on the common assumption of producers’ optimising behaviour and it does not require a priori assumptions about the presence of market power. Calculating the markdown in this way is equivalent to adopting the production approach introduced by Hall (1988), and later popularised by De Loecker and Warzynski (2012) and De Loecker et al. (2016). The unusually rich data allow us to overcome various limitations of markdown estimations in much of the literature.
Importantly, we also disentangle wage markdowns from price markups, which are embedded in the ‘naïve’ comparison of marginal product of labour and the wage paid to employees.
Product market regulation and wage markdown
Using this approach, we provide reduced-form estimates of the elasticity of wage markdowns to investment restrictions, which is around 0.25. This implies that NIL related entry barriers in the product market increased markdowns by around 4.3% in our sample. The results are robust to a battery of tests and are also consistent with an event study regression based on a change of the NIL as the ‘event’ (Figure 2). The absence of pre-trends in the event study further relieves endogeneity concerns for the instrument. In addition, we probe the robustness of our results using an alternative identification strategy based on a Bartik instrument exploiting the differential exposure to regulated product markets across 274 commuting zones. Such design minimizes the potential endogeneity of changes to the NIL and labour market power in a given product market, thus providing further reassurance against possible endogeneity biasing our results.
Figure 2 The impact of product market regulation on plant-level wage markdowns in the event study design
We then test empirically to what extent firm entry can explain this effect, as postulated by the model. We first show that investment restrictions are indeed powerful predictors of subsequent entry by manufacturing firms at the product market level. Imposing at least a restriction in a product market reduces firm entry in that market by 40%. We then build on this finding and instrument the entry in a product market with investment restrictions using the NIL. The resulting two-stage least-squares (2SLS) estimates imply an elasticity of markdown with respect to product market regulation that is almost identical to the reduced form elasticity. This supports the channel identified in the model as driving the relation between product market regulation and labour market power.
Finally, we examine the extent to which these effects are affected by minimum wage policy, which is set at the provincial level in Indonesia. By setting a floor to the wage, this policy could limit the extent of the wedge between the marginal product of labour and the wage. Indeed, the results suggest that minimum wage policy is less relevant in unrestricted product markets, where employers’ labour market power is lower. However, in restricted markets where employers have substantial power, minimum wages limit the extent to which labour can be exploited.
Our analysis suggests that pro-competitive product market policies can mitigate labour market distortions. This provides support for the policies advocated in Naidu et al. (2018) and Marinescu et al. (2021), which propose to extend antitrust measures from product to labour markets. Any changes in industry concentration, due for instance to mergers and acquisitions, should also be evaluated in terms of its impact on concentration in the labour market.
Amodio, F, P Medina, and M Morlacco (2022), “Labor Market Power, Self-Employment and Development”, IZA Discussion Paper 15477.
Benmelech, E, N K Bergman, and H Kim (2022), “Strong employers and weak employees how does employer concentration affect wages?”, Journal of Human Resources 57(S): S200–S250.
Berger, D, K Herkenhoff, and S Mongey (2022), “Labor market power”, American Economic Review 112(4): 1147–93.
Brooks, W J, J P Kaboski, Y A Li, and W Qian (2021), “Exploitation of labor? classical monopsony power and labor’s share”, Journal of Development Economics 150: 102627.
Calì, M and G Presidente (2023), “Product Market Monopolies and Labor Market Monopsonies”, World Bank Policy Research Working Paper No. 10388.
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