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VAM-Velferd, arbeid og migrasjon

Causes and consequences of labor market inequality

Alternative title: Årsaker til og konsekvenser av ulikhet i arbeidsmarkedet

Awarded: NOK 11.9 mill.

Project Number:

314283

Application Type:

Project Period:

2021 - 2026

Funding received from:

Partner countries:

Public debate is increasingly focused on a subject that economists have been analyzing for several decades: causes and consequences of labor market inequality. Much popular discussion concerns the "top 1 percent". While relevant, the top 1 percent covers only a small fraction of the population. This project focuses on the "other 99 percent". The primary goal of the project is to provide novel empirical evidence on both the causes and consequences of labor market inequality, and how economic inequalities among households are attenuated by government policies such as a progressive tax-transfer system. So far, the project has resulted in three articles that are either published or accepted for publication in leading economic journals, and one article published as part of a PhD thesis. These works are summarized below. Below are summaries of two of the project’s recent works. In "Facts and Fantasies about Wage Setting and Collective Bargaining" (Journal of Economic Perspectives, 2022), we document and discuss salient features of collective bargaining systems in the OECD countries, with the goal of debunking some misconceptions and myths and revitalizing the general interest in wage setting and collective bargaining. We hope that such an interest may help close the gap between how economists tend to model wage setting and how wages are actually set. Canonical models of competitive labor markets, monopsony, and search and matching all assume a decentralized wage setting where individual firms and workers determine wages. In most advanced economies, however, it is common that firms or employer associations bargain with unions over wages, producing collective bargaining systems. We show that the characteristics of these systems vary in important ways across advanced economies, with regards to both the scope and the structure of collective bargaining. Drawing on high-quality micro data, we illustrate the "anatomy" of the wage setting in Norway, a small open economy with a two-tier bargaining system. We present empirical evidence on the composition of wages and changes in wages, wage inequality within and between industries, and pattern bargaining. In line with the theory of collective bargaining, we find that centrally negotiated base wages act as common wage floors within industries, while the locally negotiated wage drifts produce significant differences in wages across workers depending on the productivity of the firm in which they are employed. The least productive firms pay wages that are approximately equal to their labor productivity, while the most productive firms pay wages that are much lower than labor productivity, earning positive (quasi-)rents on the workers. Studying the relationship between average wages and average labor productivity across industries, we find little evidence of a systematic relationship between the wage floors and the average productivity of the industries. This finding can be interpreted as evidence of strong horizontal coordination across industries in Norway’s collective bargaining system. Finally, comparing average growth rates in wages and productivity across major industries, we find that while the manufacturing industry has had among the lowest growth rates in productivity, it has been able to retain a high growth in wages. We interpret this as empirical support of a strong influence of export-led pattern bargaining in the Norwegian system of collective bargaining. In "How Americans Respond to Idiosyncratic and Exogenous Changes in Household Wealth and Unearned income" (NBER Working Paper No. 29000), we study how Americans respond to idiosyncratic and exogenous changes in household wealth and unearned income. Our analyses combine administrative data on U.S. lottery winners with an event-study design that exploits variation in the timing of lottery wins. Our first contribution is to estimate the earnings responses to these windfall gains, finding significant and sizable wealth and income effects. On average, an extra dollar of unearned income in a given period reduces pre-tax labor earnings by about 50 cents, decreases total labor taxes by 10 cents, and increases consumption by 60 cents. These effects are heterogeneous across the income distribution, with households in higher quartiles of the income distribution reducing their earnings by a larger amount. Our second contribution is to study how additional wealth and unearned income affect a wide range of behavior, including geographic mobility and neighborhood choice, retirement decisions and labor market exit, family formation and dissolution, entry into entrepreneurship, and job-to-job mobility. Lastly, we carefully compare our findings to those reported in existing lottery studies. This comparison reveals that existing U.S. studies substantially underestimate wealth and income effects because they use measures that understate earnings responses and overstate wealth changes associated with lottery wins.

The goal of this project is to provide novel empirical evidence on both the causes and consequences of labor market inequality, and how economic inequalities among households are attenuated by government policies such as a progressive tax-transfer system. Using data from Norway, the United States, and several European countries, we will carry out three separate but related projects, each of which includes specific paper proposals that are descripted in the application. The goal of the first project is to address several bias and misspecification issues with the AKM model, a commonly used statistical model of wage determination, in order to accurately characterize the empirical determinants of wages in several countries, including Norway and the U.S. The second project investigates the underlying economic and social causes of labor market inequality, by examining the empirical importance of three hypotheses for why observationally equivalent workers are paid differently: unobserved productivity differences across workers, imperfect competition in the labor market, and compensating differentials due to non-wage attributes of jobs. The goal of the third project is to examine how public policy, such as the tax-transfer system, may attenuate the economic consequences of inequality in the labor market. To this end, we will synthesize the empirical evidence on how economic decisions and outcomes are affected by the Nordic labor market regulations and government policies. We also aim to develop an empirical framework to identify, estimate, and interpret how shocks to worker productivity and changes in local labor market conditions affect household income and consumption, and to explore the degree of insurance against adverse income shocks provided by the progressive Norwegian tax-transfer system. In each project, the analyses will combine theory and credible identification strategies with large administrative datasets that can be linked to supplementary data sources.

Funding scheme:

VAM-Velferd, arbeid og migrasjon