Sources of Wage Inequality

University Of Wisconsin-Madison, Madison WI

Investigators

Abstract

Proposal No: 0617438 Institution: Northwestern University NSF Program: ECONOMICS Principal Investigator: Taber, Christopher Title: Sources of Wage Inequality ABSTRACT The sources and consequences of wage inequality are of both academic interest and an important policy issue. The four most important models of post-schooling wage determination in economics are human capital, the Roy model, the compensating differentials model, and the search model. The key aspect of the Roy model is comparative advantage in which some workers earn more than others as a result of different skill levels at labor market entry. Workers choose the job for which they achieve the highest level of earnings. By contrast, in a compensating wage differentials model a worker is willing to be paid less in order to work on a job that they enjoy more. Thus, workers with identical talent can earn different salaries. Finally, workers may have had poor luck in finding their ideal job. This type of search friction can also lead to heterogeneity in earnings as some workers may work for higher wage firms. Researchers on wage heterogeneity have generally emphasized one model over others. While separating human capital accumulation from the others is quite common, we know surprisingly little about the relative importance of the other three sources of inequality. Thus, it is not possible to infer the relative importance of each of these explanations of wage heterogeneity. The goal of the proposed is to uncover the contribution of these different components to overall earnings inequality by developing and estimating a structural model of wage heterogeneity that encompasses all four explanations of wage inequality. The intellectual merit of the project arises from the following four activities. This research will derive the first empirically implementable structural model of earnings inequality containing the four major post schooling wage models in labor economics, human capital, the Roy model, the compensating differentials model, and the search model. It will show how the parameters of the model can be uniquely identified from the type of data at our disposal. Using a unique data set on individuals, the model will be estimated with the latest and appropriate econometric techniques. Finally, the estimated parameters of the model will be used to uncover the relative importance of the four sources of wage inequality. The results of this research will have broader impacts in several directions. For example, the results of this research project will provide empirically grounded frameworks that can be used to understand a number of labor market phenomena. The results of this research could improve our understanding of low income labor market policy. If the goal is to counteract earnings inequality, the four models have very different policy implications.