Three aspects of wage inequality
This work presents three contributions to the study of wage inequality. The first is concerned with between-group wage inequality, the second and third with within-group or residual wage inequality. Chapter 1 reviews the literature on wage inequality. Chapter 2 explores the possibility that a shift in consumer demand might have played a role in the rise of wage inequality. If more skilled workers demand more skill-intensive goods, then an exogenous increase in relative skill supplies will also induce a shift in relative demand. This channel reduces the need to rely on technology and trade to explain the patterns in the data. I illustrate this mechanism with a simple two-sector general equilibrium model. The empirical part demonstrates that in the UK more educated and richer workers demand more skill-intensive goods. Calibration of the model suggests that this induced demand shift can explain 3% of the total relative demand shift in the UK between 1981 and 1997. The baseline model only explains between-industry shifts in skill upgrading and wage inequality, while empirically, most of these changes took place within industries. An extension of the model with different qualities of goods and labor can also explain some of the within-industry changes. Chapter 3 provides some empirical evidence and a theory of the relationship between within-group wage inequality and the increasing dispersion of capital/labor ratios across firms. In the empirical part, I document the increasing variance of capital/labor ratios across firms in the US labor market. I also show that the increase in the capital intensity variance across firms is associated with the increasing wage variance across workers. To explain this empirical fact, I adopt a search model where firms differ in their optimal capital choice. The decline of the relative price of equipment makes the firm distribution of capital/labor ratios more dispersed. In a frictional labor market this force generates wage dispersion among identical workers. Simple calibration of the model indicates that the dispersion of capital/labor ratios can explain up to one third of the total increase in residual wage inequality. Chapter 4 presents a study of earnings instability. I use the PSID to decompose the rise in wage inequality in a permanent and a transitory component. I consider separately job stayers and job changers. I find that the result of increasing earnings instability (increasing variance of the transitory component of earnings) holds in a sample of job changers but does not hold in a sample of job stayers. I interpret the evidence in a search and matching model with on-the-job search. The increasing variance of the transitory component of earnings is modeled as a mean-preserving spread of the distribution of productivity shocks. The mean-preserving spread induces on-the-job search on a wider range of productivity values and reduces the range of values where workers stay on the same job. As a result, the variance in the transitory part of earnings is increased for job changers. The effect on the wage variance of job stayers is ambiguous and depends on the composition of stayers between non-seekers and seekers who did not find a new job.