Do Employers Have More Monopsony Power in Slack Labor Markets?

Abstract

This article confronts monopsony theory’s predictions regarding workers’ wages with observed wage patterns over the business cycle. Using German administrative data for the years 1985 to 2010 and an estimation framework based on duration models, the authors construct a time series of the labor supply elasticity to the firm and estimate its relationship to the unemployment rate. They find that firms possess more monopsony power during economic downturns. Half of this cyclicality stems from workers’ job separations being less wage driven when unemployment rises, and the other half mirrors that firms find it relatively easier to poach workers. Results show that the cyclicality is more pronounced in tight labor markets with low unemployment, and that the findings are robust to controlling for time-invariant unobserved worker or plant heterogeneity. The authors further document that cyclical changes in workers’ entry wages are of similar magnitude as those predicted under pure monopsonistic wage setting.

Labor's Share, the Firm's Market Power, and Total Factor Productivity

“…Potential reasons include search frictions, mobility costs, or job differentiation, all of which impede workers' responsiveness to wages. This causes the labour supply curve to the single firm to be upward‐sloping, rather than being horizontal as under perfect competition” (Hirsch, Jahn, and Schnabel , 3).…”

Do firms’ wage-setting powers increase during recessions?

“…Similarly, work in the monopsonistic framework is better able to match firms' changes in wage-setting power over the business cycle to the wages of new hires than to the wages of workers who are already employed [1]. The similarity in the predictions of these alternative models to the monopsonistic model suggests that the simple supply and demand framework of the monopsonistic model provides a straightforward and accurate way to analyze changes in the real wage over the business cycle.…”

“…Some studies address this issue by following the same workers over a long period of time and by controlling for the time invariant characteristics (often difficult to observe) of a worker [1]. Other studies use "natural experiments" such as changes in public policy to create random variation in wages.…”

“…Three non-experimental studies measured firm wage-setting power over the business cycle, using data from the US and Germany [1], [2], [3]. One of the studies examines labor markets between World War I and World War II [1], while the other two employ more contemporary data.…”

“…One of the studies examines labor markets between World War I and World War II [1], while the other two employ more contemporary data. Each study finds that the elasticity of labor supply to the firm is lower during poor economic times; in other words, firms are able to drive a larger wedge between productivity and pay during recessions than during upswings.…”