Unemployment Risk and Wage Differentials

Abstract

Workers in less-secure jobs are often paid less than identical-looking workers in more secure jobs. We show that this lack of compensating differentials for risk can arise in equilibrium when all workers are identical and firms differ only in job security (i.e. the probability that the worker is not sent into unemployment). In a setting where workers search for new positions both on and off the job, the worker’s marginal willingness to pay for job security is endogenous, increasing with the rent received by a worker in his job, and depending on the behavior of all firms in the labor market. We solve for the labor market equilibrium and find that wages increase with job security for at least all firms in the risky tail of the distribution of firm-level risk. Unemployment becomes persistent for low-wage and unemployed workers, a seeming pattern of unemployment scarring created entirely by firm heterogeneity. Higher in the wage distribution, workers can take wage cuts to move to more stable employment.