Working Paper: CEPR ID: DP3190
Authors: Alison L. Booth; Gylfi Zoega
Abstract: This Paper provides microfoundations for wage compression by modelling wage-setting in a world of heterogeneous workers and firms. Workers are differentiated by observable innate ability. A high-ability worker confers on a firm an externality, since their ability raises the average level of talent within that firm and increases the range of tasks that can be performed. This gives some firms monopsony power in the market for labour trained to do more advanced tasks. Firms will assign their better workers to the more advanced tasks performed within their ranks, and wages are compressed within firms, so that low-ability workers are paid more, relative to their talent, than high-ability workers. The model also offers an explanation for why wage inequality has recently increased in some countries: exogenous changes that increase labour market competition can disproportionately benefit higher ability workers and widen the wages distribution.
Keywords: heterogeneous workers; hierarchical assignment; models; monopsony; wage compression
JEL Codes: J24; J31; J42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher innate ability among workers (J24) | Higher average ability level within a firm (D29) |
| Higher average ability level within a firm (D29) | Increased complexity of tasks performed (D29) |
| Higher innate ability among workers (J24) | Increased complexity of tasks performed (D29) |
| High-ability workers (J24) | Positive externalities for firm productivity (D21) |
| Positive externalities for firm productivity (D21) | Wage compression (J31) |
| Higher innate ability among workers (J24) | Wage compression (J31) |
| Labor market competition increases (J29) | Wage inequality widens (J31) |