Skill or Luck? Search Frictions and Wage Differentials

The paper seeks to explain a collection of empirical regularities concerning inter– and intra–industrial wage differentials. For example, the model is consistent with the following well established set of observations: (i) Controlling for other variables, the wage of displaced workers is strongly related both to the characteristics of the pre– displacement employer and the characteristics of the post–displacement employer, (ii) wage differentials are correlated across occupations, and (iii) the pattern of wage differentials are similar across countries with different market institutions. Our framework is a search–matching model with heterogeneous worker quality, heterogeneous technology, and endogenous wage policies (wage posting or bargaining). The model has equilibria in which wage bargaining coexists with a variety of posted wages. Higher wages attract more able workers on average. For a given posted wage, there may be an interval of worker productivities such that both the worker and the firm are satisfied with the match. Hence, a worker’s wage reflects luck as well as skill. ∗Stockholm School of Economics, Box 6501, S—113 83 Stockholm, Sweden. ∗∗Trade Union Institute for Economic Research, Wallingatan 38, S-111 24 Stockholm, Sweden. The research is financed by Swedish Council for Research in the Humanities and Social Sciences and by Jan Wallander och Tom Hedelius’ Stiftelse. We are grateful to Charlie Bean, Peter Diamond, Espen Moen, Karl Ove Moene and several seminar participants for helpful comments and suggestions. Remaining errors are ours.