Reallocation and the Role of Firm Composition Effects on Aggregate Wage Dynamics

Effrosyni Adamopoulou,Marta De Philippis,Federico Giorgi,Emmanuele Bobbio

doi:10.2139/ssrn.3129257

Abstract

Aggregate wages display little cyclicality compared to what a standard model would predict. Wage rigidities are an obvious candidate but a recent strand of the literature has emphasized the need to take into account the growing importance of worker composition effects during downturns. With reference to the Italian case we document that also firm composition effects increasingly matter in explaining the aggregate wage dynamics, i.e. aggregate wage growth has been lifted up by the increase in the employment weight of high wage firms. To the extent that this reallocation occurs towards more productive firms, the composition effects may also reflect an efficiency enhancing mechanism. We use a newly available dataset based on social security records covering the universe of Italian employers be-tween 1990 and 2013 and employ a standard measure of allocative efficiency on wages paid across firms. We show that this measure has improved over time since prior to the recent downturn and that it is aligned, at the sectoral level, with measures of productivity growth and market openness to competition. We then focus on the recent downturn and find that large firms were able to adjust wages more than small firms, and that small firms instead adjusted employment to a larger extent. Finally, we document that the continued improvement in the measure of allocative efficiency over this period correlates positively with measures of economic activity (evolution of employment and value added) across sectors.

Highlights

During downturns, aggregate wages appear to respond very little to business cycle fluctuations
By applying the simple BO exercise in Italy, we find that composition effects matter substantially for aggregate wage dynamics and increasingly so after the recent crisis
Composition effects have played an important role in determining the dynamics of aggregate wages during the last decade

Summary

Introduction

Aggregate wages appear to respond very little to business cycle fluctuations. While our results for workers are in line with the previous literature (Hines, Hoynes and Krueger, 2001, for instance), which shows that job losses during downturns disproportionally affect workers with lower than average wages, to our knowledge, we are the first to quantify the increasing contribution of employers’ characteristics in explaining aggregate wage dynamics Given this first set of results, we believe that the firm component is worth a more thorough investigation. We distinguish which mechanism lies behind the results we obtain from the BO decomposition by applying on firm-level wage data a standard tool taken from the reallocation literature, the so-called OP decomposition This method allows us to distinguish the part of aggregate wage changes that is due to: (i) changes in the type of firms entering/exiting the market; (ii) uniform changes in the average wage of all firms; and (iii) changes in the relative size of firms, i.e. on how workers are allocated across higher/lower paying firms

The OP decomposition

Conclusions

Findings

Dynamic OP decomposition