Understanding the minimum wage effects on imperfect product and labour markets

Project: Research

Project participants

  • Hirsch, Boris (Project manager, academic)
  • Mertens, Matthias (Project manager, academic)
  • Müller, Steffen (Project manager, academic)


Whereas minimum wages are present in most countries nowadays, their effects remain a controversial issue among scientists and policymakers. In particular, little is known on how the competitive environment of firms affects their adjustments to the labour cost shock induced by a minimum wage. Against this background, this project is first to study in detail how firms’ product and labour market power shape their responses to the minimum wage. To measure product and labour market power at the firm level, the project relies on a recent methodology that allows to infer both types of market power from production function estimates. Specifically, this methodology provides direct firm-level measures of the mark-up of prices over marginal costs, of firms’ monopsony power in case of below competitive wages, and of workers’ monopoly power in case of above competitive wages. We implement this methodology using high-quality administrative firm panel data from the Official Firm Data for Germany (Amtliche Firmendaten für Deutschland, AFiD) and then study in three papers how product and labour market imperfections shape firms’ responses to the minimum wage. In terms of identification, we rely on a firm-level triple differences approach to investigate the effects of the introduction of the minimum wage in Germany in 2015 depending on firms’ product and labour market power prior to the minimum wage introduction. The three papers of this project not only revisit the employment effect of the minimum wage and investigate how product and labour market imperfections shape firms’ employment response, but also provide first comprehensive evidence on the interaction between both types of market imperfections and further responses. Apart from employment, we consider firms’ adjustments in terms of output, product prices, productivity, and labour substitution. Understanding such interactions is vital both from a scientific and policy point of view for several reasons. Textbook models of labour market monopsony predict that the minimum wage may not only improve workers’ wages but also increase employment, output, and efficiency. Studying the prevalence of labour market imperfections and how they shape the minimum wage effect thus offers the opportunity of explaining the modest employment effects of minimum wages found empirically and promises insights into the likely welfare implications of the minimum wage. Textbook models of goods market monopoly predict that firms may pass through their increased labour costs by raising product prices for consumers who then pay for the minimum wage. Studying how firms’ responses to the minimum wage vary with their product market power is thus important for understanding how the minimum wage affects worker welfare and is likely to reveal crucial interactions between competition and labour market policy. Therefore, we expect our findings to be of significant interest to scientists and policymakers alike.