Unobserved Worker Quality and Inter-Industry Wage Differentials†

This study quantitatively assesses two alternative explanations for inter-industry wage differentials: worker heterogeneity in the form of unobserved quality and firm heterogeneity in the form of the firm’s willingness to pay (WTP) for workers’productive attributes. We develop an empirical model of labor demand and apply a two-stage nonparametric procedure to recover worker and firm heterogeneities. In the first stage we recover unmeasured worker quality by estimating a nonparametric hedonic wage function. In the second stage we infer each firm’s WTP parameters for worker attributes by using first-order conditions from the demand model. We apply our approach to quantify inter-industry wage differentials on the basis of individual data from NLSY79 and find that worker quality accounts for approximately two thirds of the inter-industry wage differentials.