Wage Formation: Towards Isolating Search and Bargaining Effects from the Marginal Product

Abstract

This article estimates the importance of workers’ outside options in wage determination. The article uses the predictions of search and bargaining theory and proposes novel identification strategies to separate the respective effects of outside options from those of unobserved productivity. Using an administrative panel database for Germany, this study exploits differences in both the employment composition across cities of Germany and mobility across jobs as sources of variation for identification. The main finding of the article is that a 10% increase in the outside options of a worker generates a 7% wage increase.