Research

Abstract: This paper examines how labor market power shapes firms' decisions to innovate and growth. We develop an endogenous growth model where firms optimize R&D spending to increase their future productivity while facing an upward-sloping labor supply curve, generating monopsony power. This creates two opposing distortions: (1) monopsonistic firms have stronger incentives to innovate and grow as they enjoy larger profits, but (2) firm growth increases (infra-)marginal labor costs by pushing firms up the labor supply curve, which reduces the returns to productivity-enhancing innovation. Theoretically, the first effect dominates for small firms, while the second is stronger for large firms. We test these predictions using rich firm-level data from the German manufacturing sector (1995–2018) to estimate firms' productivity and labor market power. Empirically, we find that, conditional on size, labor market power negatively correlates with R&D investment. Small (large) firms in high-monopsony-power regions exhibit relatively high (low) R&D spending, compared to competitive labor markets, which aligns with our model predictions. When  combining our model with the data, we find that the distortinary impact of labor market power on firms' innovation choices has a sizeable negative effect on aggregate productivity and can explain a substantial share of regional productivity differences in the German manufacturing sector.

Ongoing project