Discussion Paper Details

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Title: If You're so Smart, Why Aren't You Rich? Wage Inequality with Heterogenous Workers?

Author(s): Alison L Booth and Gylfi Zoega

Publication Date: February 2002

Keyword(s): heterogenous workers, hierarchical assignment models, monopsony and wage compression

Programme Area(s): Labour Economics

Abstract: This Paper provides microfoundations for wage compression by modelling wage-setting in a world of heterogeneous workers and firms. Workers are differentiated by observable innate ability. A high-ability worker confers on a firm an externality, since their ability raises the average level of talent within that firm and increases the range of tasks that can be performed. This gives some firms monopsony power in the market for labour trained to do more advanced tasks. Firms will assign their better workers to the more advanced tasks performed within their ranks, and wages are compressed within firms, so that low-ability workers are paid more, relative to their talent, than high-ability workers. The model also offers an explanation for why wage inequality has recently increased in some countries: exogenous changes that increase labour market competition can disproportionately benefit higher ability workers and widen the wages distribution.

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Bibliographic Reference

Booth, A and Zoega, G. 2002. 'If You're so Smart, Why Aren't You Rich? Wage Inequality with Heterogenous Workers?'. London, Centre for Economic Policy Research.