RDP 2023-02: Did Labour Market Concentration Lower Wages Growth Pre-COVID? 1. Introduction

Wages growth was slow in Australia, and many other advanced economies, across a variety of measures in the years leading up to COVID-19 (Australian Treasury 2017; Arsov and Evans 2018). Much of the weakness could be explained by standard determinants. For example, Cassidy (2019) uses one of the RBA's standard models of wages growth to show that most of the decline in wages growth can be explained by higher labour market spare capacity, and lower inflation and inflation expectations. Still, wages growth remained moderately lower than expected even when allowing for these factors. This caused increasing speculation among academics and policymakers about whether deeper structural factors were weighing on wages growth (Lowe 2018; Australian Treasury 2017; Andrews et al 2019; OECD 2020).

The impetus to understand weak wages growth is clear. Wages growth plays a crucial role in inflation dynamics, in determining government revenue, and in the welfare of individuals. Knowing whether and what structural factors are weighing on wages is crucial to understanding future wages growth outcomes. It is also important in creating policy to counter the structural factors. To the extent that these structural factors remain, they could continue to weigh on wages in the post-COVID period.

One explanation that has received attention in recent years is the possibility of decreasing competition and increasing concentration among employers (OECD 2020). All else equal, where there are fewer employers competing for workers, workers have fewer outside options to leverage in wage negotiations. As such, employers tend to have more power to set lower wages. This is referred to as monopsony power.

The focus on employer concentration and labour market power as a potential explanation for low wages growth is unsurprising given the documented increase in concentration in product markets (Hambur forthcoming; De Loecker at al 2020). Increases in employer concentration could help explain other economic phenomena witnessed over the past decade, such as declines in measures of job switching in Australia (Deutscher 2019) and overseas (Moscarini and Postel-Vinay 2017). There is likely to be less job switching when there are fewer employers to switch between.

While numerous papers have documented the impact of employer concentration on wages overseas, there has to date been no work for Australia. Accordingly, in this paper I provide the first Australian evidence using a comprehensive de-identified Linked Employer-Employee Dataset (LEED) based on administrative tax data.

First, I document the degree of concentration in Australian labour markets and how this changed between 2005 and 2016. I find that Australian labour markets are slightly less concentrated than overseas markets, although there is a great deal of variation. For example, more remote markets tend to be more concentrated. Overall, concentration has been broadly unchanged since the mid-2000s.

I then examine the relationship between concentration and wages. I find that wages tend to be lower in more concentrated markets (all else equal), consistent with economic theory. But even within markets there is a lot of variation. Larger firms tend to exert more market power and, therefore, set lower wages (after accounting for differences in productivity). This suggests that models of oligopsony may be more appropriate than models of monopsony, consistent with recent papers such as Berger et al (2021).

Further, the impact of concentration on wages appears to have increased over time. For any given level of concentration, its impact on wages has more than doubled compared to the mid-2000s. So, despite concentration remaining broadly unchanged over the period, it may still have weighed on wages growth pre-COVID. Simple back-of-the-envelope partial equilibrium estimates suggest wages were a little under 1 per cent lower on average from 2011 to 2015 than they would have been had the impact of concentration not increased.

Finally, I examine several potential explanations for the increased impact of given levels of concentration. The results suggest declining firm dynamism and entry rates over the 2010s played an important role as incumbents faced less competition from new firms for workers. In turn, this potentially weighed on aggregate wages growth.

Declines in union membership may have also contributed to the increased impact of concentration by weakening offsetting worker bargaining power as higher levels of union membership appear to provide some offset to employer concentration. However, declining firm entry rates appear to have played a more significant role in making employer concentration more impactful.

Finally, evidence suggests that declining occupational mobility may also have weighed on worker wages by limiting their ability to leverage job opportunities outside their current occupation. However, the interaction between declining occupational mobility and the impact of concentration on wages is less clear.

These results highlight the dual channels through which declining firm dynamism and competitive pressures can weigh on wages growth: indirectly through its impact on productivity (Andrews and Hansell 2021; Andrews et al 2022; Hambur forthcoming); and more directly by impacting worker bargaining power. These results motivate an ongoing focus on potential obstacles to firm entry, growth and dynamism, and how that affects wage and growth outcomes. They also suggest that wages growth could remain lower than expected if dynamism remains subdued.

The next section of the paper provides an overview of the international literature on labour market concentration, monopsony and wages. Section 3 discusses the data used in the analysis. Section 4 documents labour market concentration in Australia, and how it has changed over time. Section 5 examines the relationship between wages and labour market concentration, while section 6 examines explanations for the increasing impact of concentration. Section 7 concludes.