Product Market Monopolies and Labor Market Monopsonies

This paper unveils a novel externality of product market regulation in the labormarket. It shows theoretically and empirically that higher barriers to entry in product markets translate into higheremployers’ labor market power, measured by the wage markdown—the ratio between the marginal product of labor andthe wage. The literature suggests that this wedge can distort factor allocation, resulting in lower aggregateoutput and employment, but also in higher inequality through a reduction in the labor share of national output. Usingvariation in investment restrictions across 346 manufacturing product markets in Indonesia, the analysisfinds that wage markdowns increase by 25 percent in product markets that become subject to investment restrictions. Theresult is rationalized using a simple oligopsony model in which higher entry costs reduce the equilibrium number offirms, thereby limiting employment options for workers and, hence, their labor market power. Instrumental variableestimates support the model’s prediction that lower entry is the main driver of the positive relationship betweeninvestment restrictions and wage markdowns.