Equilibrium Effects of the Minimum Wage: The Role of Product Market Power

Abstract:

We study the role of product market power in the equilibrium effects of the minimum wage. Higher minimum wages are known to induce workers' reallocation from small to larger firms. If firms set prices strategically, they optimally respond to larger market shares by raising their markups. We call this novel mechanism concentration channel of the minimum wage. We show that product market power can overturn the commonly-held view that higher minimum wages boost the aggregate labor share. On the one hand, the minimum wage pushes the labor share up by compressing firms' monopsony power on the labor market. On the other hand, the concentration channel depresses the labor share by fuelling firms' monopoly power on the product market. Consistently with our theory, we document on Italian balance-sheet data that the firm-level labor share response to higher sectoral minimum wages is decreasing in product market concentration. To quantify the aggregate labor share response, we construct a novel structural model embedding frictional labor markets and oligopolistically-competitive product markets. We estimate the model on Italian social security data replicating key labor market statistics for different worker types and the detailed structure of sectoral product markets. We find that the labor share is hump-shaped in the level of minimum wage with a peak around the median wage. Our results stress the importance of factoring in product market power for a correct evaluation of minimum wage reforms.