This article examines the effect of product market competition on firms’ willingness to pay for workers of different skills. Using a panel of UK workers and two different quasi‐natural experiments, I show that returns to skill within an industry increase with competition. I also investigate the mechanisms behind this relationship: in addition to the indirect effects that operate through union bargaining and skill‐biased technical change, there is evidence for a direct effect of competition beyond those channels. I provide an explanation for this finding based on the relationship between competition and the sensitivity of profits to cost reductions.
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