When Do Firms Profit from Wage Setting Power?
Abstract
In standard models of labor market monopsony, the profits derived from firmmonopsony power depends on the firm's labor supply elasticity. There are two
puzzles facing these standard models. First, different standard approaches to
estimating labor supply elasticities produce dramatically different estimates and hence
measures of profits from monopsony power. Second, commonly used low labor
supply elasticities imply profit shares of aggregate income that are too high after
accounting for price markups and capital income. This paper argues that both of these
issues arise from the same limitation - that firms can increase employment only by
raising wages. To address this, we develop a tractable model where firms use both
higher wages and costly recruiting expenditures to attract workers. Firms have wage
setting power due both to search frictions and workers' heterogeneous preferences over workplaces. We show that whether firms profit from their wage setting power
depends on the shape of firms recruiting cost function, and the rents acquired by
firms from wage setting power can be dissipated by recruiting costs. In a calibrated
quantitative model that also accounts for the strategic behavior of a large firm, profits
from wage setting power account for 6% of labor market-wide marginal product and
5% of output. Our findings suggest that wage setting power alone does not imply
profits for firms that exploit this power.