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Presented By: Department of Economics

When Labor Rigidities Meet Financial Constraints: Evidence from Italy

Erin Gibson, University of Michigan, Practice Job Talk

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I explore the role of rising unit labor costs, proxied by collectively bargained wage floors, in depressing the Italian manufacturing sector. I answer this in two steps. First, using a comprehensive dataset of Italian manufacturing firms from 1999-2019, I find that a one percentage point increase in the sectoral wage floor is associated with a 0.28 percentage point contraction in firm-level investment and a 0.21 percentage point contraction in firm-level employment. These effects are highly heterogeneous and indicative of a role for financial frictions: Small, highly leveraged firms experience contractions three times larger than those of large, low-leverage firms. To understand the mechanisms behind this and quantify aggregate effects, I develop a model where overlapping generations of heterogeneous firms face both collateral constraints and industry-wide wage floors. Calibrated to Italy's 25 percent unit labor cost increase between 2000-2015, the model predicts aggregate contractions in manufacturing investment (3.5 percent), employment (2.1 percent), and real GDP (1.9 percent). A decomposition reveals that financial frictions amplify the direct effects of wage rigidity by approximately 30 percent through an interaction effect. The results highlight how labor market institutions and financial frictions can interact to generate persistent effects on firm dynamics and aggregate performance.

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