Two Tales of Market Power: Labor Markets under the Emergence of Contractor Firms

Abstract: This paper examines how competition among contractor firms affects wages of both outsourced and in-house workers. Using matched employer–employee and fiscal data for France (2009–2021), I document an empirical puzzle: while the rise in outsourcing across local labor markets is largely driven by the entry of new contractor firms, consistent with greater competition, dispersion in contractor profit margins has simultaneously increased, driven by the top of the distribution—suggesting weaker competition. I reconcile this puzzle by showing that contractor firms respond to intensified competition by cutting wages, thereby preserving or even expanding margins for some firms. Exploiting a shift-share instrument based on initial employment composition across occupations and locations, I find that a one-standard-deviation increase in exposure to outsourcing reduces contractor firms’ profit margins by about 12 pp and outsourced workers’ gross hourly wages by roughly 2€. To capture the broader equilibrium effects, I then build a search-and-matching model with endogenous outsourcing decisions and imperfect competition among contractor firms. I show that the responsiveness of demand for contractor firms' services to price changes depends not only on price itself but also on the distribution of fixed costs of production across firms. In markets characterized by high average fixed costs relative to in-house productivity, most firms prefer to outsource. Less dispersion in firms' fixed costs reinforces this trend by aligning more firms with the average organizational cost, reducing the mass of firms near the outsourcing threshold and thereby lowering the price elasticity of demand for labor services. Crucially, the number of contractor firms is endogenous and responds to these distributional shifts. A decline in demand elasticity raises contractor firms' mark-ups, even as the decrease in dispersion encourages market entry. However, the increased number of contractor firms does not fully offset the reduction in elasticity, leading to lower wages across both contractor firms and non-outsourcing firms.

Presentations: Macro Seminar (PSE), Séminaire de l'ERUDITE (Créteil University), Brown Bag Seminar of Innovation Economics (Collège de France), Labor/Public Workshop (Sciences Po)

Selected for presentation at the 7th QMUL PhD Workshop in Economics and Finance, and 24th Journées LAGV (AMSE)

Email me for a draft, at justine.feliu@psemail.eu