Luca Lorenzini (UCLA, Anderson School of Management)
This paper investigates how labor market sorting and segmentation influence labor market power, aggregate efficiency, and welfare distribution. Using matched employer-employee data from Germany, I show that low-ability workers are disproportionately employed by smaller, lowproductivity firms due to selective hiring by firms offering higher wage premiums. Motivated by this evidence, I develop a model that examines monopsony power driven by heterogeneous firm selection of the workforce. In this framework, more productive firms are larger, apply stricter hiring standards, and selectively employ higher-ability workers, resulting in an ability-based segmentation of the labor market, where not all firms are available as options to every worker. This creates localized competition, with firms primarily competing with others targeting similar workers. Less productive firms exert greater labor market power over lower-ability workers, while more productive firms over higher-ability ones. The model predicts welfare losses of 26% to 53% for workers, especially large for those at the lower end of the ability distribution, who face a restricted choice set as they are excluded by most firms, thereby reducing competition. Entrepreneurs experience welfare gains of 65%. Predicted output loss is 0.1%, significantly lower than the 8% seen in traditional models without labor market segmentation.