Globalisation and Rent Sharing

by Pawel Bukowski, Stephen Machin and David Soskice

Rising wage dispersion, a falling labour share of income and stagnating real wages have been re-connected recently with two major labour market trends. The first is the growing labour market power of firms and the falling bargaining power of workers, and the second is that globalisation might be also responsible for the profound changes in the distribution of income (e.g. a Stolper-Samuelson effect). Are these two seemingly distinct explanations of rising income inequality connected? Surprisingly, to date relatively little attention has been paid to the relationship between globalisation and the balance of power between workers and firms.

Our research project (here) seeks to understand basic empirical patterns in the balance of power in the European manufacturing labour market and its connection to the forces of globalisation. To this end we use a concept of rent sharing, that is, a firm-level relationship between individual firms’ economic rents and wages. While it is theoretically unclear whether rent sharing reflects the labour market power of firms or bargaining power of workers, we propose a novel method to identify the latter. The idea is based on the theoretical conclusion that the labour market power of firms leads to rent sharing because the co-movement of wages and profits is mediated through changes in employment size. Therefore, to ‘switch-off’ this channel we control for the current level of employment in our rent-sharing equation.

The first set of results provides robust evidence for positive rent sharing - that wages rise in tandem with the company profits. This is not in line with a standard model of perfect competition, which implies that the financial situation of a firm cannot influence its wages. Rent sharing is, however, much weaker today than it was before 2008.

The second set of results shows that around one-third of the level of rent sharing is a reflection of the labour market power of companies (i.e., monopsonistic competition), and two-third a reflection of the bargaining power of workers. The fall of rent sharing is driven equally by the two channels.

Finally, we show that the participation in global value chains (GVC) matters more for the balance of power than direct trade. Outsourcing of production to foreign suppliers through GVCs and high share of export in production reduce the labour market power of both firms and workers, leading to a market structure better described by the model of perfect competition. Conversely, outsourcing to domestic suppliers is correlated with less competitive labour markets, through the stronger monopsonistic power of firms and bargaining power of workers. Surprisingly, we find that import penetration does not influence the balance of power on the labour market. It is worth highlighting here that these findings concern the manufacturing industries only and are not driven by any time-invariant differences between them.

Findings of this paper speak to the profound change in the competitiveness of labour markets, driven by a fall of the bargaining power of workers and a fall of the monopsonistic power of firms. The deteriorating labour market position of workers has been linked with the decline of unions, the rise of domestic outsourcing or the spread of insecure job contracts. Changes in the monopsonistic power of firms have been studied in connection with the changes in market structure, the prevalence of restricted contracts and occupation, as well as limited domestic geographic mobility and migration.

With this in mind, we argue that globalisation is another major driving force affecting the labour market trends. In particular, we highlight that industries participating in GVCs have

more competitive labour markets compared to industries sourcing from domestic suppliers or producing in-house. From the firms’ side, more intensive international inter-firm competition might reduce their wage-setting power. From the workers’ side, the potential mechanisms include lower outside options, the threat of offshoring or changing occupational structure. Understanding the importance of these forces is a needed direction for the future research and may open the door to understand some of the discontent with globalisation.

From the policy perspective, the main lesson from this project is that globalisation needs to go hand in hand with workers protection. There might be a risk that a dual-economy, with high-productive multinational companies operating on competitive markets, and low-productive domestic companies endowed with a wage-setting power. On the other hand, weak unions and employment protection law in sectors exposed to globalisation might limit the extent to which benefits that accrue from globalisation are shared with labour. If this is the case, policy with a goal of securing equitable growth should then focus on improving productivity, innovativeness and competitiveness of these parts of economy, which are not directly involved in trade networks, and on empowering workers in industries participating in trade networks.

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