ESMT Berlin and IZA

We build a model where firm size is a source of labor market power. The key mechanism is that a granular employer can eliminate its own vacancies from a worker’s outside option in the wage bargain. Hence, a granular employer does not compete with itself. We show how wages depend on employment concentration and then use the model to quantify the effects of granular market power. In Austrian micro-data, we find that granular market power depresses wages by about ten percent and can explain 40 percent of the observed decline in the labor share from 1997 to 2015. Mergers decrease competition for workers and reduce wages even at non-merging firms. ∗Jarosch: Princeton and NBER, gregorjarosch@gmail.com. Nimczik: ESMT Berlin and IZA, jan.nimczik@esmt.org. Sorkin: Stanford and NBER, sorkin@stanford.edu. Thanks to seminar and conference participants at Barcelona GSE: EGF, Berkeley, Calgary, EES Stockholm, Minnesota Workshop in Macroeconomic Theory, NBER SI: Macro Perspectives, NBER SI: Labor Studies, New York Fed, Princeton, STLAR, SED, Stanford, and the West Coast Search and Matching Workshop for helpful comments and conversations. All errors are our own, please let us know about them. There has been a revival of interest in understanding the effect of market power on many aggregate outcomes, including wages. In this paper, we develop a new model of size-based labor market power. We build on the structure of a canonical search model in the Diamond-Mortensen-Pissarides tradition, but relax the assumption of a continuum of firms. In our setup, the vacancies of a granular employer—a firm controlling a strictly positive fraction of employment—do not compete with the vacancies of the same employer. Specifically, employers exert market power by effectively eliminating their own vacancies from a worker’s outside option in the wage bargain. As a consequence, the distribution of employment shares affects wages and we derive a structural mapping from a microfounded concentration index to average wages. We use our framework to gauge the consequences of levels and trends in labor market concentration for wages (or equivalently, the labor share) in the Austrian labor market from 1997 to 2015, and to study the effects of hypothetical mergers. We have three main findings. First, market power in the labor market depresses wages by about ten percent. Second, changes in market structure can explain over 40 percent of the observed decline in the labor share in Austria from 1997-2015. Finally, merging the two largest employers in each labor market reduces competition for workers and, as a consequence, wages fall even at non-merging firms: in our simulations, market-wide wages decline by on average six percent. The first key ingredient in our model is that employers each control a strictly positive fraction of vacancies—i.e., they are granular. In a frictional market, competition is encoded in workers’ outside options. Because a granular employer controls a positive fraction of vacancies, one part of the workers’ outside option is the employer it is currently matched with. Thus, in a standard setup, a granular employer would compete with its own future vacancies. The second key ingredient is that firms can (largely) avoid the competition with their own vacancies. Wages are set through standard Nash-bargaining. But we adopt a matching process where unemployed workers apply to jobs subject to coordination frictions. As a consequence, vacancies frequently have multiple applicants they can choose from. We assume that if the firm and worker fail to reach an agreement and the worker applies to another vacancy at the same firm, then the firm selects another worker from the queue of applicants. Hence, the firm does not compete with its own vacancies. Our model implies that large firms pay less and wages are lower in more concentrated markets. The intuition for the wage result is that workers’ outside options are worse when bargaining with a larger firm. The intuition for the concentration result is that firms in more concentrated markets compete less for workers and thus pay lower wages. We derive a closed form expression for average wages which shows that market structure is summarized by a particular concentration measure. The measure depends on the sum of squared employment shares (as in the Herfindahl-Hirschman Index (HHI)) as well as on all the higher order terms. Intuitively, the source of the power terms is the possibility of repeated encounters with the same employer who does not compete with itself. The inclusion of the higher order terms means that this measure is distinct from the HHI since it places more weight on large employers. However,