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

19 Pages Posted: 21 Feb 2002

See all articles by Alison L. Booth

Alison L. Booth

Australian National University (ANU) - Research School of Social Sciences (RSSS); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Gylfi Zoega

University of Iceland; University of London - Birkbeck College; Centre for Economic Policy Research (CEPR)

Date Written: February 2002

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.

Keywords: Heterogenous workers, hierarchical assignment models, monopsony, wage compression

JEL Classification: J24, J31, J42

Suggested Citation

Booth, Alison L. and Zoega, Gylfi, If You're so Smart, Why Aren't You Rich? Wage Inequality with Heterogenous Workers (February 2002). Available at SSRN: https://ssrn.com/abstract=301376

Alison L. Booth (Contact Author)

Australian National University (ANU) - Research School of Social Sciences (RSSS) ( email )

Canberra, Australian Capital Territory 0200
Australia
+61 2 6125 3285 (Phone)
+61 2 6125 0182 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Gylfi Zoega

University of Iceland ( email )

IS-101 Reykjavik
Iceland

University of London - Birkbeck College ( email )

Malet Street
London, WC1E 7HX
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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