Why Do Large Firms Willingly Pay High Wages in Developing Countries?

Cai, Hongbin and Wang, Miaojun and Yan, Se (2014): Why Do Large Firms Willingly Pay High Wages in Developing Countries?

Abstract

Using a simple game-theoretical model, this paper provides a new explanation for why large firms in developing economies may willingly pay higher wages than market wage rate. We show that large firms can strategically create entry barriers to the modern sector by setting high wage standards. They may do so to reduce competition or to distort the government's resource allocation. Focusing on the latter case, we also show that the size of the primitive sector will be larger than the efficient level, and public resource allocation will be biased in favor of incumbent large businesses despite the benevolent nature of the government. Using a survey of Chinese industrial firms, we find that industrial concentration is positively correlated with the size-wage effect, and such effect is stronger in less developed provinces. These findings are consistent with our theoretical prediction.

• Item Type: MPRA Paper
• Language: English
• Keywords: size-wage effect; entry deterrence; government resource allocation
• Subjects: J - Labor and Demographic Economics > J2 - Demand and Supply of Labor > J21 - Labor Force and Employment, Size, and Structure; J - Labor and Demographic Economics > J3 - Wages, Compensation, and Labor Costs > J31 - Wage Level and Structure ; Wage Differentials; J - Labor and Demographic Economics > J4 - Particular Labor Markets > J42 - Monopsony ; Segmented Labor Markets; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L11 - Production, Pricing, and Market Structure ; Size Distribution of Firms

References

Akerlof, George A. and Janet L. Yellen, 1988, Fairness and Unemployment, American Economic Review papers and proceedings, 78:44-49.

Akerlof, George A. and Janet L. Yellen, 1990, The Fair Wage-effort Hypothesis and Unemployment, Quarterly Journal of Economics, 105:255-284.

Bai, Chong-En, Jiangyong Lu, and Zhigang Tao, 2009, How Does Privatization Work in China? Journal of Comparative Economics, 37: 453-470.

Brandt, Loren, Johannes Van Biesebroeck, and Yifan Zhang, 2009, "Creative Accounting or Creative Destruction? Firm-Level Productivity Growth in Chinese Manufacturing," NBER Working Paper No. 15152.

Brown, Charles and James Medoff, 1989, The Employer Size-Wage Effect, Journal of Political Economy, 97: 1027-1059.

Burdett, Kenneth and Dale T. Mortensen, 1998, Wage Differentials, Employer Size, and Unemployment, International Economic Review, 39:257-73.

Masson Chu, Woosik and Robert T. Masson, 1990, Waging Campaign to Retain Monopoly: Employee Compensation as Price Signals to Deter Entry, mimeo, Cornell University.

Fehr, Ernst, Georg Kirchsteiger, and Arno Riedl, 1993, Does Fairness Prevent Market Clearing? An Experimental Investigation, Quarterly Journal of Economics, 108:437-459.

Feng, Shuaizhang and Bingyong Zheng, 2009, Cherry-Picking in Labor Market with Imperfect Information, IZA Discussion Paper No. 4309.

Feng, Shuaizhang and Bingyong Zheng, 2010, Imperfect Information, On-the-Job Training, and the Employer Size-Wage Puzzle: Theory and Evidence, IZA Discussion Papers No. 4998.

Little, Ian M.D., Dipak Mazumdar and John M. Page Jr., 1987, Small Manufacturing Enterprises: A Comparative Study of India and Other Economies, Oxford University Press, New York.

Lucas, Robert E., 1978, On the Size Distribution of Business Firms, Bell Journal of Economics, 9: 508-523.

Magruder, Jeremy R., 2012, High Unemployment Yet Few Small Firms: The Role of Centralized Bargaining in South Africa, American Economic Journal: Applied Economics, 4(3): 138-166.

Oi, Walter and Todd Idson, 1999, Firm Size and Wages, in O. Ashenfelter and D. Card (Eds.), Handbook of Labor Economics, 3:2165-2215. Amsterdam, North-Holland.

Rabin, Matthew, 1998, Psychology and Economics, Journal of Economic Literature, 36:11-46.

Rauch, James E., 1991, Modeling the Informal Sector Formally, Journal of Development Economics, 35: 33-47.

Salop, Steven C. and David T. Scheffman, 1983, Raising Rival's Costs, American Economic Review, 73:267-271.

Schaffner, Julie A., 1998, Premiums to Employment in Larger Establishments: Evidence from Peru, Journal of Development Economics, 55: 81-113.

Schmidt, Christoph M. and Klaus F. Zimmermann, 1991, Work Characteristics, Firm Size and Wages, Review of Economics and Statistics, 73:705-710.

Strobl, Eric and Robert Thornton, 2002, Do Large Employers Pay More in Developing Countries? The Case of Five African Countries, IZA Discussion Paper No. 660.

Summers, Lawrence H., 1988, Relative Wages, Efficiency Wages, and Keynesian Unemployment, American Economic Review papers and proceedings, 78:383-388.

Todaro, Michael P., 1994, Economic Development, Longman, New York & London.

Troske, Kenneth R., 1999, Evidence on the Employer Size-Wage Premium from Worker-Establishment Matched Data, Review of Economics and Statistics, 81:15-26.

Velenchik, Ann D., 1997, Government Intervention, Efficiency Wages, and the Employer Size Wage Effect in Zimbabwe, Journal of Development Economics, 53:305-338.

Williamson, Oliver, 1968, Wage Rates as a Barrier to Entry: The Pennington Case, Quarterly Journal of Economics, 85:85-116.

Zabojnik, Jan and Dan Bernhardt, 2001, Corporate Tournaments, Human Capital Acquisition, and the Firm Size-Wage Relation, Review of Economic Studies, 68:693-716.