Abstract
Increasing wage inequality between similar workers plays an important role for overall inequality trends in industrialized societies. To analyze this pattern, we incorporate directed labor market search into a dynamic model of international trade with heterogeneous firms and homogeneous workers. Wage inequality across and within firms results from their different hiring needs along their life cycles and the convexity of their adjustment costs. The interaction between wage posting and firm growth explains some recent empirical regularities on firm and labor market dynamics. Fitting the model to capture key features obtained from German linked employer-employee data, we investigate how falling trade costs and institutional reforms interact in shaping labor market outcomes. Focusing on the period 1996-2007, we find that neither trade nor key features of the Hartz labor market reforms account for the sharp increase in residual inequality observed in the data. By contrast, inequality is highly responsive to the increase in product market competition triggered by domestic regulatory reform.
Highlights
Wage inequality has been on the rise in many industrialized countries
Taking our calibration as the baseline, we evaluate whether trade, labor and product market reforms can explain the changes in German labor market outcomes documented above
Recent contribution by Feenstra (2014) and Demidova (2016) have tried to extend the model to a general equilibrium setup.58. These considerations suggest that an important avenue for future research is to embed variable markups in our economy in order to carefully identify the effects of different policy changes on inequality, first among them the effect of trade liberalization
Summary
Wage inequality has been on the rise in many industrialized countries. According to a recent OECD study, since the mid-1980s, inequality increased in 17 out of 22 OECD member states for which data are available (OECD, 2011). We calibrate the model to German linked employer-employee data and provide a quantitative assessment of the role of international trade, domestic labor and product market reforms in explaining inequality dynamics. A common feature distinguishing Cosar et al (2016) and our paper from the rest of the literature, is the use of a dynamic model with convex adjustment costs This weakens the response of wages to trade liberalization as firms optimally spread their adjustments over time. Recent papers by Launov and Waelde (2013, 2016) and Krebs and Scheffel (2013) provide a quantitative analysis of the Hartz reforms They focus on unemployment and not on wage dispersion, and they do not contrast institutional reform to product market liberalization.
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