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Monopsony Makes Firms Not Only Small but Also Unproductive: Why East Germany has Not Converged

Rüdiger Bachmann¹; Christian Bayer²; Heiko Stüber³; Felix Wellschmied⁴

¹ University of Michigan, CEPR, CESifo, ifo, and IZA , · ² Rheinische Friedrich-Wilhelms-Universität Bonn, CEPR, CESifo, and IZA , · ³ Hochschule der Bundesagentur für Arbeit, IAB, and IZA , · ⁴ Universidad Carlos III de Madrid and IZA , Spain

When employers face a trade-off between being large and paying low wages—and in this sense have monopsony power—some productive employers decide against building large business networks, forgo sales, and remain small. These decisions have adverse consequences for aggregate labour productivity. Using high-quality administrative data from Germany, we document that East German plants (compared to West German ones) face steeper size-wage curves, invest less in their business networks, remain smaller, and are less productive. A model with labour market monopsony, product market power, and business network investments matching these features of the data predicts a 10% lower aggregate labour productivity in East Germany.

DOI

10.1093/restud/rdag033

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en

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