What’s Causing Wage Stagnation in America?

Since the 1970s, growth in “real wages” (that is, the value of the dollars paid to employees after being adjusted for inflation) has slowed compared to overall economic productivity.

Previous economic research has pointed to two explanations for wage stagnation, especially among lower-paying jobs in the manufacturing sector: globalization has flooded the market with cheap goods from China and sapped domestic-manufacturing wages in the process; and technology has steadily ushered in more job-killing automation.

Yet both trends offer incomplete explanations, explains Efraim Benmelech, a professor of finance at the Kellogg School.

“None of these explanations goes back long enough in time,” he says. Wage growth has been slowing since the early 1970s, but “the competition with China starts somewhere in the 1990s, and the process of automation is a product of the last ten or fifteen years.”

What else could be to blame for wage stagnation?

New research by Benmelech, and Nittai Bergman and Hyunseob Kim of the National Bureau of Economic Research, indicates that the hidden culprit is what economists call labor-market concentration—too few employers competing for the same workers on a local level.

In other words, say a factory employee is dissatisfied with his pay and hears that a competitor across town is offering higher wages. He may switch employers. However, if there is no competitor to switch to—that is, if the local labor market is highly concentrated—then he must accept the wages at his current job.

“There has been a discussion in recent years about what happened to middle-class Americans,” Benmelech says. “We don’t say that we have the only explanation, but we have an explanation that is consistent and can explain the long-term phenomenon of stagnant wages.”

The Role of “Monopsony Power” on Wage Stagnation

The ability of a company to depress wages due to lack of competition for workers is known as “monopsony power.” Benmelech wondered if monopsony power, caused by local-labor-market concentration, might be related to the larger wage-stagnation trends among American workers over the past four decades.

To investigate, Benmelech and his coauthors obtained data from the U.S. Census Bureau to assemble county-level figures on wages and productivity from 300,000 manufacturing plants across the country from 1977 and 2009.

This let the researchers see how productive individual plants were, in terms of operating expenses and the value of shipments, as well as the wages they paid, and how these figures changed over the course of three decades. They focused on manufacturing because it is easier to measure productivity there than in service industries, Benmelech explains.

The depth and breadth of the data allowed the researchers to make detailed comparisons between plants across geography and time to look for evidence of local monopsonies and their corresponding effect on wages.

For instance, imagine a company owned two plants of similar size and productivity in two counties but faced competition for workers in only one of those counties. If the data showed that the company paid its workers less in the county where it was the only plant in town, that would suggest evidence that the firm was using its local monopsony power to depress wages. And if those wages didn’t grow over the years to keep pace with the plant’s overall economic productivity, the researchers would be able to see that as well.

“We take advantage of the fact that many manufacturing firms in the U.S. are very large and operate multiple plants,” Benmelech says. “That lets us compare what the same firm is doing in the same industry across different plants.”

The researchers were also able to use these data to measure local-labor-market concentration empirically, using a standard formula called the Herfindahl-Hirschman Index (HHI). HHI is often used by antitrust regulators to determine how competitive a product or service market is.

In the researchers’ formulation, a county with only one company to employ workers within the same industry would have an HHI of 1; the more employers there are competing for workers, the closer the figure approaches zero.

A Grim Picture on Wage Stagnation

Given such robust data, the researchers were able to clearly demonstrate a connection between labor-market concentration, monopsony power, and decreased wages.

They first established that counties with higher HHIs paid workers less compared to those with less concentrated labor markets. Furthermore, the effect doubled in strength over the course of the researchers’ sample period.

“It’s getting worse,” Benmelech says.

By analyzing the factory productivity and wage data, the researchers also confirmed that monopsony power allows companies to keep wages down even when a plant is profitable and productive.

The picture for employees gets even grimmer when you factor in one of the previous explanations for wage stagnation.

The research shows that globalization in manufacturing delivers a double whammy to workers: it leads some plants to close, which then allows the remaining plants in the area to keep wages down for those workers who did not lose their jobs.

“In some counties, because some jobs went to China and caused plants to close, the remaining employers in those counties now have much more power,” Benmelech says. “So as a result, they can pay lower wages.”

One bit of good news, though: the analysis confirms that employee unions can act as a check on local monopsonies.

The researchers used data from the Union Membership and Coverage Database and found that even in counties where competition between firms for workers is low, wages were relatively higher when unions were present.

“When the employees are stronger and have more bargaining power, then even a concentrated employer cannot pay them the low wages that it would otherwise pay,” Benmelech explains.

Multiple Explanations for Wage Stagnation

Despite the strength of the findings, Benmelech cautions that “whenever you have an important economic question, it is unlikely that there will be only one explanation.” Globalization, high-tech automation, and labor-market concentration are probably all influencing wage stagnation and income inequality.

Benmelech adds that the study’s biggest takeaway applies to other industries as well. “The notion of [monopsony] market power—that when employers have more power relative to employees, they would pay them lower wages—that’s nothing that is unique to manufacturing,” he says.

As for what might be done to mitigate these disheartening trends—beyond unionization—Benmelech is currently investigating how raising local minimum wages might affect the interaction between employer monopsonies and stagnant pay.

“So many things have happened in the last 40 years—you have different policies, and the world is changing. But employer concentration seems to be an important factor,” he says. “It probably explains at least 30 percent of the fact that wages have not been increasing. And for economists, that’s a large amount of explanatory power.”