A Theory of Wage and Turnover Dynamics∗

This paper presents a theory — built on job search, firm specific human capital, and disreputable contracting — to provide a unified explanation for a host of widely documented findings on wage and turnover dynamics. In particular, the theory reconciles two seemingly inconsistent facts: evidence that past wage growth on a job reduces turnover; and yet, using the same data, evidence that there is no significant variation in wage growth rates among jobs because of lack of serial correlation of wage growth. The main results of the paper are as follows. First, average wage growth is higher in high learning jobs because higher outside job offers are more likely to be matched in jobs that generate more firm-specific rents. Second, past wage growth on a job is negatively related to turnover since worker-firm separations are less likely in high learning jobs. Third, although productivity increases on the job are serially correlated, wage increases are not necessarily serially correlated. Finally, the model implies asymmetric tenure effects on wages and turnover, consistent with weak positive wage effects and strong negative turnover effects that are both widely documented in the labor literature. ∗I thank Prajit Dutta, Rajiv Sethi, Nachum Sicherman, Paolo Siconolfi, and Karl Sigman for many helpful discussions. I also thank Stephanie Aaronson, Tavis Barr, Stephen Cameron, Duncan Foley, Michael Gibbs, Erica Groshen, Cynthia Howells, Todd Idson, Tack-Seung Jun, Brendan O’Flaherty, Sanjay Tikku, Joe Tracy, Michael Waldman, and seminar participants at Columbia, Hunter, New York Federal Reserve Bank, Rutgers and University of Delaware for comments and suggestions.