Larger Companies Pay Higher Wages and Globalization Helps Us to Understand Why

By Jun.-Prof. Dr. Jens Wrona (Foto)

It has long been known that employees in exporting companies receive higher wages than comparable employees in companies that do not export. The incompatibility of this finding with the law of uniform wages in a perfectly competitive labour market led to the extension of the standard model of international trade to include various labour market imperfections. Interestingly, the two best known theories to explain exporters'; wage premiums are both based on a rent-sharing mechanism. This does not mean that companies pay higher wages out of sheer good faith simply because their high productivity allows them to do so without being in the red. Rather, there must be a concrete economic calculation for this, so that from the company's point of view it is optimal to increase its employees to participate in the success of the company through higher wages. This may, for example, involve fairness considerations, which ensure that the employees feel fairly remunerated in comparison with the capital owners and are therefore willing to perform the maximum work input. Alternatively, more productive firms may require a skilled workforce and therefore be more selective in hiring their employees. In order to ensure a sufficient number of applications and a high rejection rate at the same time, the prospective salary must be correspondingly high if the selection process is successful. Regardless of the concrete micro-foundation, in both cases there is a positive correlation between the company's profit and the amount of the salary. If companies follow the maximization of profit, every decision made in this sense, such as exporting to foreign markets, leads to higher wages for the employees.

Wage Effects of Offshoring

If one follows the logic of the rent-sharing model, the relocation of production steps abroad, commonly referred to as offshoring, should not only lead to higher profits but also to higher wages for the remaining domestic employees. A look at the latest empirical evidence on the wage and employment effects of production relocation reveals a different, more differentiated picture: In particular, comparatively low-skilled production workers in the manufacturing sector are often affected by falling wages as a result of intensified offshoring. Low wages in relocating companies are always associated with a decline in domestic employment and an expansion of foreign production capacity.

Market Power in the Labour Market

In a recent research paper on the wage and employment effects of exporting final products and importing preliminary or intermediate products, we extend the standard model of foreign trade theory to include an imperfection in the labour market, which is being considered in this context for the first time. From the perspective of their (potential) employees, firms differ not only in the level of their wages but also in non-monetary job aspects, such as the commuting distance to the workplace. Both factors determine the choice of the workplace, which is why the labour supply function of each company also depends positively on the wage set. From the employees'; point of view, a sufficiently high wage compensates for other negative factors such as a comparatively long commuting distance, which in turn means that a larger proportion of employees will choose this company rather than another. The additional loyalty of employees to an individual company through non-monetary job aspects gives the company a certain market power as the sole buyer (monopsonist) within its niche of the labour market. In contrast to a perfectly competitive labour market, in which even a small deviation from the market wage leads to the immediate arbitrage of all employees towards the company with the highest wage, monopsonistic competition results in a positive correlation between the size and the wage of a company. Companies which are confronted with a high demand for their products due to their high productivity and their correspondingly low prices need a correspondingly large number of workers for production. However, since the recruitment of additional workers increasingly includes those employees for whom the company is not a natural choice due to disadvantageous non-monetary job aspects, a correspondingly high wage rate must be offered as compensation.

Effects of Globalisation with Monopsonistic Competition in the Labour Market

In contrast to rent-sharing models discussed above, the wage of a company in monopolies depends on the number of employees in the respective labour market and not from the global profit of the company. A company that relocates part of its production abroad to maximize its profits requires fewer domestic workers and achieves a reduction in employment through wage cuts, which causes those workers with the least loyalty to the company to turn their backs on the company. Conversely, exporting firms that need additional labour to serve foreign markets can only expand their domestic employment if they are willing to pay higher wages than comparable firms that supply only the domestic market. Our model of monopsonistic competition in the labour market is thus able to explain both the wage and employment effects of international trade in end products and the wage and employment effects of international trade in preliminary and intermediate products.

Conclusion

The fact that larger companies generally also pay higher wages is an empirically proven fact. What is less clear is which combination of different labour market theories can explain this general correlation. The reaction of individual companies to different globalisation shocks (exporting versus offshoring) allows additional conclusions to be drawn: For example, a synchronicity in the adjustment of wages and employment can be shown, which can be interpreted as an indication of an upwardly inclined company-specific labour supply function in the case of monopsonistic competition in the labour market.

This article is also published in the DICE Policy Brief.

DICE PUBLIKATION

Hartmut Egger, Udo Kreickemeier, Christoph Moser & Jens Wrona (2019), Exporting and Offshoring with Monopsonistic Competition, CEGE Discussion Paper No. 376.