Labour market power and wage inequalities in European regions

Abstract

Despite a gradual decline in interpersonal wage inequality in many advanced economies, substantial spatial disparities in wages persist across European regions. This paper examines the extent to which employer wage-setting power (labour market power) contributes to these regional wage differences, with particular attention to its heterogeneous effects across the wage distribution and between metropolitan and nonmetropolitan areas. While urban labour markets are generally associated with higher wages due to agglomeration economies and greater returns to skills, they may also amplify employer wage-setting power through stronger worker competition, weaker collective action, and greater employer discretion.

The paper makes two main contributions. Conceptually, it develops a framework linking labour market power to wage compression across the wage distribution, arguing that employer wage-setting power is likely to impose larger penalties on high-wageworkers, particularly in metropolitan labour markets. Empirically, it provides new evidence on wage inequality across European Union NUTS 2 regions using the CompNet database. The analysis combines regional measures of wage dispersion with a comprehensive set of indicators capturing labour market imperfections, including labour markdowns, product market power, labour market concentration, and exposure to robotisation.

The results reveal persistent regional heterogeneity in wage levels and wage inequality despite Europe's comparatively moderate overall inequality. Labour markdowns are consistently associated with lower wages throughout the wage distribution, with the strongest effects at the upper percentiles, suggesting that employer wage-setting power compresses wages from above by disproportionately reducing the earnings of high-wageworkers. These findings remain robust after accounting for alternative sources of market power and technological change.

The analysis further shows that these effects are significantly stronger in metropolitan regions. Labour markdowns exert a larger wage-depressing effect in urban labour markets, especially among high-skilled and high-paid workers, suggesting that cities intensify monopsonistic pressures through dense labour market competition and weaker worker bargaining power. These findings offer a novel perspective on the interaction between urbanisation and labour market power, highlighting the microeconomic mechanisms through which metropolitan labour markets shape wage outcomes.

Overall, the paper identifies labour market power as an important but often overlooked determinant of regional wage inequality in Europe. The results suggest that reducing territorial disparities requires not only redistributive policies but also stronger labour market institutions, including collective bargaining and enforcement mechanisms, alongside place-based policies that preserve the productivity advantages of cities while limiting excessive employer wage-setting power.