Earnings Dynamics and Firm Level Shocks

There has been an increased interest in understanding pay policies of firms, and in particular the extent to which firm level productivity shocks are transmitted to worker’s wages. Such departures from perfect competition and the law of one price have been motivated by the developments in search theory starting by the seminal models of Burdett and Mortensen (1998) and Mortensen and Pissarides (1994). While the theoretical justification for departures from the law of one price are compelling the empirical evidence is not quite there. First, most equilibrium search models that have been estimated on empirical data assume no productivity shocks. These include recently Postel-Vinay and Robin (2002) and Cahuc, Postel-Vinay and Robin (2006). An exception is the model of Lise, Meghir and Robin (2010) which allows for the effect of productivity shocks in a context of a model with productive complementarities. However, their model is estimated on individual level data and hence cannot measure directly the productivity shocks, but infers them from the structure of the model. The recent availability of matched employer-employee data gives rise to major new opportunities in this direction. Second, models that have been estimated on matched employer-employee data, without a specific economic structure, such as Abowd, Kramarz and Margolis (1999), have focussed on sorting and firm/worker heterogeneity rather than the dynamics of shocks. A recent paper by Guiso, Pistaferri and Schivardi (2005) (GPS) has indeed measured the impact ∗Stockholm University and IFAU †University College London, Yale University, IFS, IFAU and IZA ‡Stanford University and IZA