"Monopsony Makes Firms not only Small but also Unproductive: Why East Germany has not Converged"

When employers face a trade-off between being large and paying low wages—and in this sense have monopsony power—some productive employers decide to acquire few customers, forgo sales, and remain small. These decisions have adverse consequences for aggregate labor productivity. Using high-quality administrative data from Germany, we document that East German plants (compared to West German ones) face steeper size-wage curves, invest less into marketing, remain smaller, and are less productive. A model with labor market monopsony, product market power, and customer acquisition matching these features of the data predicts ten percent lower aggregate labor productivity in East Germany.

Keywords: aggregate productivity, plant heterogeneity, collective bargaining, monopsony power, size-wage curve, customer capital, size distortions