Worker Skills or Firm Wage-Setting Practices? Decomposing Wage Inequality Across 20 OECD Countries

Abstract

What drives differences in pay between firms? To answer this question, we build a harmonised cross-country linked employer-employee data set to analyse the role of firms in wage inequality since the 2000s in 20 OECD countries. The main finding is that, on average across countries, changes in the dispersion of average wages between firms explain about half of the changes in overall wage inequality. Two-thirds of these changes in between-firm wage inequality, i.e. about a third of overall wage inequality, are accounted for by changes in wage premia, i.e. the part of wages that is determined by the firm rather than the characteristics of its workers. The contribution of wage premia tends to be larger in countries with decentralised collective bargaining systems and lower levels of job mobility. The remaining third, i.e. a sixth of overall wage inequality, can be attributed to changes in workforce composition, including the sorting of high-skilled workers into high-paying firms. These results suggest that firms play an important role in explaining wage inequality as wages are determined, to a significant extent, by firm wage-setting practices rather than being exclusively determined by workers’ earnings characteristics.

Keywords: Wage inequality, firm wage premium, productivity

JEL Classification: D2, J31, J38