Unraveling the Wage-Output Disconnect: The Role of Labor Market Power

IMF Working Papers, July 9, 2024

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Model setup:
- Imperfect labor mobility between firms and sectors, implying upward-sloping labor supply curves faced by firms.
- Firms can exercise labor market power (wage markdown).
- Under oligopsony with firm heterogeneity, markdowns are represented as a function of firm labor market share.
Key model implication:
- Firms with higher labor market share (proxied by higher payroll share in their sector) exhibit a weaker relationship between changes in wages and output.

Data:
- European subsample of the ORBIS dataset spanning from 2000 to 2018.
Empirical test:
- Assess pass-through of firm value added growth to wage growth across firms with differing payroll shares in their sectors.
Robustness:
- Pattern examined across various subsamples and timeframes and after accounting for several alternative explanations.
Additional analysis:
- Interaction of firm labor market power effects with labor market downturns and overall economic downturns.

Pass-through attenuation:
- The pass-through of firm value added growth to wage growth is lower for firms with a higher payroll share in their sectors.
- Quantitatively, about one-fifth of the pass-through disappears in firms at the top 1 percentile of the payroll share distribution, relative to an atomic firm.
Robustness of result:
- The weaker wage–output link for high-payroll-share firms holds across various subsamples and timeframes and remains after accounting for alternative explanations.
Cyclicality:
- The weakening in the link between value added and wages growth due to firm labor market power intensifies during downturns in the labor market or in the overall economy.