Abstract
Abstract This paper unveils a novel externality of product market regulation in the labour market. It shows theoretically and empirically that higher barriers to entry in product markets translate into higher employers’ labour market power, measured by the wage markdown—the ratio between the marginal product of labour and the wage. Using quasi-exogenous variation in investment restrictions across 389 manufacturing product markets in Indonesia, the analysis finds that wage markdowns would have been almost 10% lower without restrictions and workers would have earned a larger fraction of their marginal product. The analysis supports the model’s prediction that lower entry is the main driver of the positive relationship between investment restrictions and wage markdowns, and that restrictions increase markdowns more in commuting zones where employers have already substantial labour market power. The restrictions do not affect employment, consistent with recent models based on search frictions and wage bargaining, but not with classical monopsony models.