Workplace Heterogeneity and the Rise of West German Wage Inequality

We study the role of establishment-specific wage premiums in generating recent increases in West German wage inequality. Models with additive fixed effects for workers and establishments are fit in four sub-intervals spanning the period from 1985 to 2009. We show that these models provide a good approximation to the wage structure and can explain nearly all of the dramatic rise in West German wage inequality. Our estimates suggest that the increasing variability of West German wages has arisen from a combination of rising heterogeneity between workers, rising variability in the wage premiums at different establishments, and increasing assortativeness in the assignment of workers to plants. In contrast, the idiosyncratic job-match component of wage variation is small and stable over time. Decomposing changes in mean wages between different education groups, occupations, and industries, we find that increasing plant-level heterogeneity and rising assortativeness in the assignment of workers to establishments explain a large share of the rise in inequality along all three dimensions. ∗We are grateful to the IAB and to Stefan Bender for assistance in making this project possible, and to Karl Schmidt, Robert Jentsch, Cerstin Erler, and Ali Athmani, for invaluable assistance in running our programs at the IAB. We also thank the Berkeley Center for Equitable Growth for funding support, and Christian Dustmann, Bernd Fitzenberger, and seminar participants at EUI Florence, Yale, Stanford, and the NBER Labor Studies meetings for many helpful comments and suggestions. Robert Heimbach, Hedvig Horvath, and Michele Weynandt provided excellent research assistance.