Misallocation and Inequality

72 Pages Posted: 19 May 2022

See all articles by Nezih Guner

Nezih Guner

Universitat Autonoma de Barcelona

Alessandro Ruggieri

University of Nottingham


For a large set of countries, we document how the labor earnings inequality varies with GDP per capita. As countries get richer, the mean-to-median ratio and the Gini coefficient decline. Yet, this decline masks divergent patterns: while inequality at the top of the earnings distribution falls, inequality at the bottom increases. We interpret these facts within a model economy with heterogeneous workers and firms, featuring industry dynamics, search and matching frictions, and skill accumulation of workers through learning-by-doing and on-the-job training. The benchmark economy is calibrated to the UK. We then study how the earnings distribution changes with distortions that penalize high-productivity firms and frictions that reduce match formation. Distortions and frictions reduce employment, average firm size, and GDP per capita. They also affect how much firms are willing to pay workers, how well high-skill workers are matched with high-productivity firms, and how much training workers receive. The model generates the observed cross-country relation between GDP per capita and earnings inequality, as well as a host of cross-country facts on firm size distribution, firms' training decisions, and workers' life-cycle and job tenure earnings profiles.

Keywords: earnings inequality, labor market frictions, correlated distortions, human capital, on-the-job training, productivity, firm size, life-cycle earning proles

JEL Classification: E23, E24, J24, O11

Suggested Citation

Guner, Nezih and Ruggieri, Alessandro, Misallocation and Inequality. IZA Discussion Paper No. 15174, Available at SSRN: https://ssrn.com/abstract=4114734 or http://dx.doi.org/10.2139/ssrn.4114734

Nezih Guner (Contact Author)

Universitat Autonoma de Barcelona ( email )

Alessandro Ruggieri

University of Nottingham ( email )

University Park
Nottingham, NG8 1BB
United Kingdom

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