Wage floors can hide employers’ underlying wage-setting power

When a business gets more orders, does it hire more people, raise pay, or both? Economists use that response to assess employers’ wage-setting power. A new preprint argues that minimum wages and negotiated wage rules can change what those measurements mean.

A measurement problem, not just a wage rule

An employer’s ability to keep pay below what an additional worker contributes is often called monopsony power. It need not involve a single employer: workers’ preferences and limited alternatives can give individual businesses some wage-setting discretion.

One way economists estimate that power is to examine a change in demand for a firm’s products. They divide the percentage employment response by the percentage wage response to estimate a firm-level labor supply elasticity: how strongly the workforce available to a firm responds to pay. A larger elasticity ordinarily implies less employer power, because attracting workers requires relatively little additional pay.

But that interpretation assumes firms can adjust wages freely. In Wage-Setting Constraints and Firm Responses to Demand Shocks, Manudeep Bhuller, Lukas Delgado-Prieto, Santiago Hermo and Linnea Lorentzen show why binding wage rules can break the connection. This briefing covers the third arXiv version, posted on November 9, 2026. It is a preprint, not a result whose peer-review status is established by the supplied evidence.

Three ways a firm can operate

The researchers build a model distinguishing three situations. An unconstrained firm voluntarily pays above the applicable wage floor. A supply-constrained firm pays the floor and hires everyone willing to work for it at that wage. A demand-constrained firm also faces a binding wage rule, but hires fewer people than are available.

Under a simple fixed wage floor, a small demand increase can make a demand-constrained firm hire more without raising pay. Dividing that employment response by a near-zero wage response produces an extremely large apparent labor supply elasticity. Yet the firm is adjusting employment because its products are more profitable to sell, not because higher wages attracted more workers.

The distinction is between potential wage-setting power and the power a firm can actually exercise under existing rules. Institutions can restrain employers while also making conventional estimates a misleading guide to their underlying discretion.

Comparing firms within two countries

The study links worker-employer records, business accounts and customs data for Portugal during 2004–2017 and Norway during 1997–2019. Its main wage measure follows workers who remain with the same employer, reducing the influence of workforce turnover on average pay.

The main analysis compares firms with above-median short-run growth in value added within their industry and event-year cohort against the remaining firms, tracking outcomes over a longer window. Value added means revenue minus purchased materials and services. Interpreting this variation as a demand shock requires assumptions about the absence of correlated changes in workers’ willingness to work for the firm.

A complementary analysis uses changes in foreign demand for firms’ existing export products and destinations around the Great Recession. These estimates are less precise, particularly for Portuguese firms.

In Portugal, the baseline classification labels firms paying within 15% of the national minimum wage as plausibly constrained. In Norway, which has no national statutory minimum wage, it uses sectoral collective bargaining coverage. These are exposure indicators, not direct observations of the model’s three regimes.

Pay responds less under constraints

Within both countries, plausibly constrained firms show smaller wage responses to demand shocks. Their implied labor supply elasticities are 8.06 versus 5.41 for unconstrained Portuguese firms, and 5.31 versus 2.79 in Norway: differences of approximately 49% and 90%.

The researchers also estimate rent-sharing elasticities, measuring the percentage wage response relative to the percentage value-added response. These are about 34% lower among constrained Portuguese firms and 38% lower among constrained Norwegian firms.

That does not mean constrained workers necessarily receive a smaller share of revenue. The model distinguishes wage levels from responsiveness: a wage floor can raise workers’ share while leaving pay less sensitive to subsequent business conditions.

A stronger test examines Portugal’s minimum-wage increases. The researchers compare demand responses across firms whose prior wages left them differently exposed to the new floors, separating wage increases associated with the floor itself from responses to demand. Longer exposure to binding constraints is associated with weaker wage responses. A causal interpretation still requires comparable underlying labor supply elasticities and parallel evolution of other influences on responsiveness.

Policy implications, with limits

In a separate model calibrated to Portugal, a policymaker who overestimates the labor supply elasticity by 15% chooses a minimum wage about 1.6% above the employment-maximizing level, missing 7.6% of the attainable employment gain. This is not a prediction of a 7.6% employment decline.

That simulation excludes firm entry and exit, and its predicted demand-constrained firm share exceeds the study’s empirical estimate. More broadly, underlying elasticities may differ across firms or change with shocks. The findings therefore warn against mechanically translating muted wage responses into weak employer power—not against wage floors or collective bargaining themselves.