From the Invisible Handshake to the Invisible Hand? How Import Competition Changes the Employment Relationship


There is a popular perception that increased competitive pressures in U.S. product markets are
turning the employment relationship from one governed by implicit agreements into one governed
by the market. In this paper, I examine whether changes in import competition indeed affect the
use of implicit agreements between employers and workers in a key aspect of their relationship,
wage setting. I focus on the extent to which employers, after negotiating workers’ wages upon hire,
subsequently shield those wages from external labor market conditions. If increased competition induces a switch from these implicit agreements to spot market wage setting, then: (1) the sensitivity of workers’ wages to the current unemployment rate should increase as competition increases; and (2) the sensitivity of workers’ wages to the unemployment rate prevailing upon hire should decrease as competition increases. I find evidence supporting both of these predictions, using exchange rate
movements to generate exogenous variation in import competition. I then show more directly
that increased financial pressure on employers is one mechanism behind these effects - both of the
wage-unemployment sensitivity changes are larger in high leverage industries than in low leverage
ones. Moreover, declines in corporate returns following increased competition directly increase the
sensitivity of wages to the current unemployment rate. There are two general interpretations of
my set of results. Wage flexibility may be a response to competition either because such flexibility
reduces the probability of costly financial distress or because lower corporate profits weaken the
enforceability of implicit wage setting agreements.

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