CEP Discussion Paper No 821 August 2007 The Evolution of Inequality in Productivity and Wages: Panel Data Evidence

Transcription

1 CEP Discussion Paper No 821 Augus 2007 The Evoluion of Inequaliy in Produciviy and Wages: Panel Daa Evidence Giulia Faggio, Kjell G. Salvanes and John Van Reenen

2 Absrac There has been a remarkable increase in wage inequaliy in he US, UK and many oher counries over he pas hree decades. A significan par of his appears o be wihin observable groups (such as age-gender-skill cells). A generally unesed implicaion of many heories raionalizing he growh of wihin-group inequaliy is ha firm-level produciviy dispersion should also have increased. Since he relevan daa do no exis in he US we uilize a UK longiudinal panel daase covering he manufacuring and non-manufacuring secors since he early 1980s. We find evidence ha produciviy inequaliy has increased. Exising sudies have underesimaed his increased dispersion because hey use daa from he manufacuring secor which has been in rapid decline. Mos of he increase in individual wage inequaliy has occurred because of an increase in inequaliy beween firms (and wihin indusries). Increased produciviy dispersion appears o be linked wih new echnologies as suggesed by models such as Caselli (1999) and is no primarily due o an increase in ransiory shocks, greaer soring or enry/exi dynamics. Keywords: wage inequaliy, produciviy dispersion, echnology JEL: D24, J24, J31, O31 This paper was produced as par of he Cenre s Produciviy and Innovaion Programme. The Cenre for Economic Performance is financed by he Economic and Social Research Council. Acknowledgemens We would like o hank David Card, Francesco Caselli, Richard Freeman, Seve Nickell, Ariel Pakes, Jusin Wolfers and paricipans a seminars a LSE, Princeon, he UK Treasury and he Royal Economic Sociey Conference for helpful commens. We acknowledge funding from he Economic and Social Research Council hrough gran RES and he Cenre for Economic Performance. Giulia Faggio is an Economis a Ciigroup Inc. in London. Kjell G. Salvanes is wih he Norwegian School of Economics and Business Adminisraion. John Van Reenen is he Direcor of he Cenre for Economic Performance, London School of Economics. Corresponding auhor: j.vanreenen@lse.ac.uk Published by Cenre for Economic Performance London School of Economics and Poliical Science Houghon Sree London WC2A 2AE All righs reserved. No par of his publicaion may be reproduced, sored in a rerieval sysem or ransmied in any form or by any means wihou he prior permission in wriing of he publisher nor be issued o he public or circulaed in any form oher han ha in which i is published. Requess for permission o reproduce any aricle or par of he Working Paper should be sen o he edior a he above address. G. Faggio, K.G. Salvanes and J. Van Reenen, submied Augus 2007 ISBN

3 I. Inroducion Wage inequaliy has increased subsanially in he Unied Saes and he Unied Kingdom in he las hiry years. Acemoglu (2002) repors ha he difference in wages earned by a worker in he 90h percenile of he wage disribuion compared o a worker in he 10h percenile increased by 40% in he US from 1971 o For he UK, he differenial increased by 48% from 1975 o 2000 (see Machin, 2003; Machin and Van Reenen, 2007). Increases in wihin-group inequaliy, i.e. increases in inequaliy among observaionally equivalen workers, accoun for a significan proporion of he rise 1. Many heories have been proposed o explain he rise in wage inequaliy. These include demand-side explanaions (rade wih developing counries or echnological change) 2, supply-side explanaions (changes in he relaive supply of highly-educaed workers across cohors) 3 and insiuions (decline in union power and/or he minimum wage 4 ). Technology-based heories have proven popular in explaining he wihin group rise. They generally assume some ype of labor marke fricion whereby workers wages are linked wih he produciviy of he worker-firm mach. Such effecs arise naurally in search based models of equilibrium wage dispersion, bu here are oher heoreical foundaions based on bargaining ha 1 Lemieux (2006) argues ha he scale of his increase may have been exaggeraed in some early sudies due o composiional effec. Auor e al. (2005) sill find a subsanial wihin componen especially in he upper ail of he disribuion. 2 See, among ohers, Machin and Van Reenen (1998) and Auor e al. (1998) for evidence ha he rapid spread of compuers has increased he demand for skills. See, among many ohers, Caselli (1999), Aghion e al. (2004) and Violane (2002) for models in which rapid echnical change increases he demand for skills and causes a rise in inequaliy. 3 See Card and Lemieux, Differences in labor marke insiuions are ofen proposed o explain cross-counry inequaliy (e.g. Blau and Kahn, 1996). Unions have declined jus abou everywhere and in he US he real value of he minimum wage fell subsanially unil he mid 1990s (see, e.g., DiNardo e al., 1996). 2

4 generae similar implicaions 5. When a general purpose echnology like informaion and communicaion echnologies (ICT) becomes available, firms will adop echnologies a differen raes and be successful o differen degrees. This generaes increased wage dispersion even for observaionally idenical workers (e.g. Violane, 2002; Aghion e al., 2002, 2004). An under-appreciaed implicaion of hese models is ha hey imply ha produciviy dispersion beween firms should also have risen. Unforunaely, very lile is known abou he evoluion of he produciviy disribuion. Wages are no a sufficien saisic for produciviy once we move away from he simples models of spo compeiion in labor markes. Some auhors have examined in deail he deerminans of he cross secional disribuion of produciviy and ohers have decomposed aggregae produciviy growh ino incumben firm produciviy growh and reallocaion effecs driven by enry, exi and he relaive growh of more producive firms. This lieraure srongly suggess ha he beween firm effecs (ignored by represenaive agen models) are very imporan 6. As useful as his lieraure is, however, i has generally focused on explaining he evoluion of he firs momen of he produciviy disribuion and has no focused on how he higher order momens of he produciviy disribuion have evolved over ime. Undersanding he dynamics of produciviy dispersion is he main conribuion of his paper. Daa consrains are an imporan reason why he changing produciviy disribuion is under-sudied. In order o examine secular changes, a long ime series 5 Morensen (2003) and Posal-Viney and Robin (2003) conain heoreical models linking equilibrium wages wih employer heerogeneiy in produciviy. They use hese models o srucurally esimae he cross secional wage disribuion in Denmark and France, respecively. Layard, Nickell and Jackman (2005) show how he link beween workers wages and employer produciviy can arise across a range of models union bargaining, efficiency wage, ren-sharing and search-based. 6 For he cross secional dispersion of produciviy see among ohers Haliwanger e al. (1999) for he U.S. and Marin (2004) for he UK. For decomposiions of produciviy changes see among ohers, Bailey e al. (1992), Olley and Pakes (1996) and Barelsman e al. (2005). 3

5 of daa is needed and firm-level daa is usually only available for such periods on he manufacuring secor 7. Since his secor only now employs abou 14% of he Briish workforce and 13% of he American workforce, i is problemaic o exrapolae o he whole economy from jus manufacuring indusries. I is paricularly a problem for produciviy analysis as he rapid decline in manufacuring in he OECD over he las hree decades is parly due o increased compeiion from less developed counries wih much lower labor coss. Wih heerogeneous firms, increases in compeiion will generally lower he produciviy dispersion (see Syverson, 2004, for a model and empirical evidence confirming he imporance of his inuiion). Consequenly, he exising sudies of he change in produciviy dispersion may have seriously underesimaed he imporance of he growh of produciviy inequaliy. Alhough producion daa on non-manufacuring is available in he US in Compusa, his only includes firms lised on he Sock Marke. Since mos firms are privae, an analysis of produciviy inequaliy ha ignored hese unlised firms is unconvincing 8. The new US Longiudinal Business Daabase is available for non-manufacuring firms in he US, bu i does no conain daa on sales or capial (see Davis e a.l, 2006). To ackle hese daa consrains we use he UK as a es bed wage inequaliy has risen rapidly since he early 1980s and we use a daa source (FAME) covering lised and unlised firms in boh manufacuring and service secors. This is an unbalanced panel and is available since he early 1980s. Figure 5a shows he headline finding from his daa where we look a he firm-specific disribuion of labor produciviy measured by value added per worker. We will discuss more daa deails laer in he paper (e.g. see Table A1 for levels of 7 See Dunne e al. (2004) for he US and Haskel and Marin (2002) for he UK. 8 For example, several papers have argued ha here is an increase in he dispersion of firm-specific shocks over ime as he variaion of firm sales growh in Compusa appears o have increased (e.g. Comin and Philippon, 2005). Unforunaely, his does no seem o be generally rue across he US economy (see Davis e al., 2006). 4

6 produciviy dispersion). We consider he 10h, 50h and 90h perceniles of he log (labor produciviy) disribuion where we normalize hese values o uniy in 1984, so he lines show wha has happened o growh a each of hese perceniles. The daa reveal a dramaic growh in he dispersion of produciviy beween firms. Produciviy increased by 60 log poins a he 90 h percenile beween 1984 and 2001 whereas i increased by only 20 log poins a he 10 h percenile (here was a growh of around 40 log poins a he median). This is a subsanial increase in produciviy inequaliy and we invesigae in deail he cause of his change in his paper. We repor hree major findings. Firs, using individual and firm level daa we find ha he vas majoriy of he increase in individual wage inequaliy in he UK is a beween-firm (raher han wihin-firm) phenomenon 9. This implies ha undersanding he evoluion of he beween firm produciviy disribuion may be criical in undersanding he beween firm wage disribuion and herefore he overall wage disribuion (we also show ha he correlaion beween wages and produciviy has become more imporan over ime). Furhermore, he vas majoriy of he growh of wage and produciviy dispersion is wihin indusries, suggesing indusry level daa on produciviy and wages will no be able o idenify he causes of he changes. Second, we show ha he increase in he produciviy dispersion (as wih he wage dispersion) is mainly in he service secor of he economy suggesing ha he focus on manufacuring in he exising lieraure has indeed underesimaed he rise of economy wide produciviy inequaliy. 9 This is ineresing as i suggess he media-grabbing aenion aached o CEO pay relaive o workers pay in he same firm may be misplaced, as he overall increase in inequaliy has relaively lile o do wih his. Neverheless, we are no including many componens of CEO remuneraion such as share opions ha are imporan. 5

7 Third, we show ha he increase in labor produciviy dispersion is mainly driven by an increase in oal facor produciviy dispersion (raher han being due o jus an increase in he dispersion of capial-labor raios or greaer soring as in Kremer and Maskin, 1996). This suggess echnological differences may be driving our resuls as suggesed in he heories of in Caselli (1999) or Acemoglu e al (2001) 10. We presen some direc evidence in line wih his idea by using ICT daa o explain he increase in wihin indusry produciviy dispersion. We also examine (and rejec) oher possible explanaions including increasing a greaer incidence of ransiory shocks, differenial enry/exi raes, insiuional changes and/or measuremen error. To our knowledge, here are only wo sudies ha have looked a changes in produciviy dispersion across many secors. Dunne e al (2004) analyse changes in he disribuion of firm produciviy across US plans. They show ha inequaliy of plan wages and produciviy dispersion increased beween 1975 and 1992 and much of his was a beween-plan phenomenon (his is consisen wih wha we find below for he UK). Haskel and Marin (2002) examined changes in labor produciviy in UK esablishmens (he Annual Business Inquiry Respondens Daabase) and also found some increase in dispersion. We argue ha since boh of hese earlier sudies look only a he manufacuring secor hey have seriously underesimaed he magniude of he change. The paper is organised as follows. In Secion 2, we briefly discuss he heoreical framework and Secion 3 deails he daa sources we use. Secion 4 describes he main resuls and Secion 5 discusses wha could explain he rends observed in he daa. Secion 6 offers some concluding commens. 10 Acemoglu e al (2001) presen a model where skill biased echnical change causes deunionizaion. This amplifies he direc effec of echnology o furher increase wage inequaliy. We invesigae insiuional change and unionisaion direcly in sub-secion 5.4. and

8 2. Theoreical framework In his secion, we use he papers by Caselli (1999) and Kremer and Maskin (1996) o generae some empirical predicions regarding he disribuion of wages and produciviy. Caselli (1999) models he impac of a echnological revoluion on he dispersion of wages and produciviy. In he Caselli model, here is a disribuion of worker ypes and machine ypes and operaing a given ype of machine requires a given ype of skill. The cos of learning a skill varies across workers and is lower for more skilled workers and a echnology is a combinaion of workers of ype i who have he appropriae skills o operae machines of ype i. A echnological revoluion occurs wih he inroducion of a new ype of machine. Since workers of differen abiliies are disribued heerogeneously across firms and for each period firms consider as given he skill composiion of heir workforce, here will be differenial adopion of new echnology by firms. High-skill workers will end o use he new echnologies since i is less cosly for hem o acquire he new skills. This model has a leas hree implicaions ha are relevan for our empirical analysis. Firsly, we will expec increased wage dispersion beween (and wihin) firms 11. Secondly, labor produciviy (value added per worker) dispersion increases beween firms due o he fac ha more skilled workers are now more producive. Thirdly, since capial is also reallocaed o is bes use oal facor produciviy increases in firms ha inroduce a new echnology so Toal Facor Produciviy (TFP) dispersion also rises. I is worh noing ha he Caselli model is differen from a pure soring model where beween firm wage (and labor produciviy) dispersion could rise because 11 There are wo effecs in operaion: a direc effec and an indirec effec. The wages of high-skill workers rise because hey now operae on more producive machines (he direc effec). There is also a reallocaion of capial away from old echnologies owards new echnologies, depressing he wages of he low skilled and benefiing he wages of he high skilled (he indirec effec). 7

9 good workers end o cluser in one ype of firm and bad workers cluser in anoher. Kremer and Maskin (1996) presen an example of such a model ha accouns for he simulaneous exisence of increased wage inequaliy and increased segregaion of workers by skill. They inroduce a se of specific assumpions regarding he firm organisaional srucure: imperfec subsiuion of workers of differen skills; complemenariy of asks wihin a plan, and differenial effecs of a worker skill depending on he ask performed. Under his se of assumpions and furher assuming a rise in he dispersion of skills across workers, Kremer and Maskin derive an equilibrium soluion where low-skill workers are sored in low-produciviy plans and high-skill workers sored in high-produciviy plans (i.e. soring or segregaion). Therefore, if dispersion of skills has increased due o increased educaional inequaliy for example, his could lead o increased soring 12. This model predics an increase in he dispersion of wages across firms. There will also be an increase in he dispersion of labor produciviy because skilled workers will be segregaed ino differen firms. However, unlike echnology-based models like Caselli s, because increased wage and produciviy dispersion is due o soring here should be no effec on oal facor produciviy dispersion. We herefore look explicily a TFP as well as labor produciviy and wages o disinguish beween he wo approaches. 12 In his model he degree of asymmery/complemenariy of asks wihin a plan is crucial in shaping he disribuion of workers across plans. The asymmery of asks in he producion funcion favours cross-maching across workers (less segregaion). Conversely, he complemenariy of asks favours self-maching (more segregaion). Workers of differen abiliies will be cross-mached up o he poin a which differences in skills or abiliies are so grea ha segregaion will be ineviable. If he disribuion of skills is sufficienly compressed, cross-maching seems o be he mos probable oucome. If he disribuion of skills is dispersed, self-maching or soring workers by skill will prevail. This gives some ambiguiy o he predicions as alhough he level of educaional achievemen has risen over ime, i is less clear wheher educaional inequaliy has risen. 8

10 3. Daa descripion All daases are described in deail in he Appendix B. The main daase we use is FAME (Financial Analysis Made Easy) which is a UK company-level panel daa se available since In Briain, all incorporaed companies are legally required o regiser heir accouns a Companies House and given a unique (VAT) regisraion number. Unlike he US, his includes no only companies lised on he Sock Exchange (which are held on daabases such as COMPUSTAT) bu also all unlised companies. In 2003, we arranged a special purchase of his daa wih a privae secor company ha has convered his daa ino elecronic form. This is unbalanced panel daa and includes all firms ha had exied he daabase prior o 2003 (by eiher bankrupcy or akeover) 13. In our main analysis, we drop some firms. In general, his could lead o selecion bias causing us o find smaller or greaer increases in inequaliy over ime, we argue in Appendix B ha hese biases are no generally large by checking he sensiiviy of he resuls o including he dropped observaions and using complemenary daases (conras Figures 5a and 5b o see ha hese exclusions have lile effec on he overall rends). Firsly, we drop firms wih less han en employees because small firms are no required o repor cerain key variables we need for our analysis such as he wages bill. Secondly, we use he consolidaed accouns of paren firms and drop he unconsolidaed accouns of heir subsidiaries. We would be double couning if we used boh parens and subsidiaries. Because some subsidiaries are below en employees, we would be missing pars of he economy if we jus used subsidiaries. Thirdly, we sar he sample in 1984 because sampling of FAME was no 13 Under UK law, firms are also required o repor a grea deal more accouning informaion on heir wage bills han in he US (where declaraion of saff expenses is a volunary iem). Because of his, we are able o consruc measures of average firm wages ha are unavailable for mos firms in he US public accouns. 9

11 complee in he early 1980s. Finally, we generally drop cerain secors: agriculure, mining, uiliies, healh and educaion. We were concerned ha hese secors were heavily influenced by sae conrol for a leas some of he sample period covered. We also drop he financial secor because of he well-known problems of measuring produciviy in banking and insurance. Our final sample we use conains abou 11,000 firms a year beween 1984 and 2001 (we cover abou 13 million workers each year). We have informaion on a large number of variables. We use informaion on employmen, capial, sales, oal worker remuneraion, gross profis and indusry. Noe ha we do no have informaion on he demographics of he workforce or hours worked. Bu we invesigae biases associaed wih his omission in sub-secion 5.4. The main measure we use for labor produciviy is value added per worker, bu we also consider using sales per worker as an alernaive. Sales has he advanage ha i is repored as a line iem in he accouns, bu he major disadvanage is ha i will be influenced by he purchase of inermediae inpus, so labor produciviy could rise simply because a firm was buying more maerials per worker his will paricularly be a problem in he service secor. We also examine oal facor produciviy (TFP) calculaed in various ways. The main way we calculae TFP is as a residual of oupus from weighed inpus, bu we also consider esimaing firm producion funcions and using he esimaed parameers o consruc TFP measures. There are numerous well-known problems wih measuring labor produciviy and TFP. Some of hese are discussed below (e.g. appropriae choice of weighs). One issue is ha he value added numeraor is no measured in physical unis so will reflec differenial mark-ups among firms as well as physical produciviy increases. 10

12 Thus, when we say produciviy i is shorhand for revenue produciviy 14. This is sill an ineresing measure o look a as he abiliy of firms o susain mark-ups is parly a reflecion of produc qualiy, and echnological change may enable firms o improve qualiy (see Appendix B and Table A2 for an analysis of he changing variaion in profiabiliy). Undoubedly, here are oher sources of marke power and he increased variaion of marke power could be a reason for increased measured produciviy dispersion. We have reason o doub his explanaion, however, as compeiion has almos cerainly increased over ime in he UK due o waves of policy-driven liberalizaion and globalizaion of markes. Oher hings equal, his would lead o a reducion in produciviy dispersion as he leas efficien firms are driven from he marke. The second daase we use is he New Earnings Survey (NES) daa which give consisen informaion on individual wages, and covers one per cen of he enire UK working populaion (hose whose Naional Insurance/Social Securiy numbers end in he same wo digis, 14). We currenly have access o daa for all years beween 1975 and 1999 in NES. We use annual gross pay as our measure of he wage in NES which maches mos closely wih FAME s measure of annual saff coss. The FAME measure is higher on average because i includes he employers payroll axes We use an economy wide deflaor, he Reail Price Index for value added. Indusry-level deflaors are available a a more disaggregaed level for manufacuring and he resuls are robus o using hese deflaors. Indusry-level deflaors are no, however, available for he service secor (due o he difficuly of defining price). Since he comparison beween manufacuring and services is imporan, we chose o repor our main resuls using a common aggregae deflaor. 15 In FAME, we canno disinguish employers payroll ax coss from oal annual saff coss. Employers Naional Insurance is a relaively small par of oal wage coss so i is unlikely his could accoun for an increase in dispersion. Neverheless, we invesigae his issue by looking a demographics (gender, age, par-ime proporion, ec.). 11

13 4. The evoluion of he wage and produciviy disribuion In his secion we documen he changes in wage (sub-secion 4.1) and produciviy (sub-secion 4.2) dispersion. We hen decompose he rends in sub-secion Trends in Wage Dispersion We begin by firs examining wage rends wih our daa. Using individual daa (NES) and firm level daa (FAME), we compue log real annual wages for male workers aged We compue values a he 90h, 50h (median) and 10h perceniles and normalise hese o uniy in The series herefore represen cumulaive changes relaive o he iniial year, We spli he sample by manufacuring and privae services. Looking a privae services firs in Figure 1, wages a he 90h percenile increased by abou fory log poins beween 1984 and By conras, he wage earned a he 10h percenile increased by only seveneen log poins, hus generaing an increase in he differenial of abou weny-hree log poins. The increase in inequaliy was sronger in he 1980s han in he 1990s. The picure does no fundamenally change when we resric he sample o include only full-ime 17 male workers or measure earnings using hourly insead of annual wages (we are using annual wages so ha we can compare hese wih FAME). Figure 2 presens he equivalen changes for manufacuring. Alhough i is clear ha wage inequaliy has also risen in his secor, he rise is much less dramaic han for services. Indeed, here is hardly any change a all in he 1990s. Sudies focusing on manufacuring will herefore miss a large par of increased inequaliy. Figures 3 and 4 presen similar evidence on wage dispersion using he FAME firm-level daa. Recall ha we are examining he disribuion in he average firm wage (raher han individual wage) in hese diagrams. Wage dispersion has risen for boh 16 See Gosling e al (2000) for similar analyses from earlier ime periods in he UK. 17 As documened in Machin (2003), he NES daa under-sample par-ime low-wage individuals so focusing on full-ime men eliminaes a lo of his bias. 12

14 secors, bu again he rise is much sronger for services (Figure 3) han for manufacuring (Figure 4). Alhough he rend analysis is ineresing, he samples are somewha differen he NES figures cover men and all firms whereas he FAME figures cover all workers and only firms wih more han 10 employees. Below in sub-secion 5.3 we mach he samples more exacly o esimae how much of he overall changes in individual wage variaion are due o an increase in iner-firm wage dispersion compared o he inra-firm wage dispersion. 4.2 Trends in he Produciviy Dispersion We discussed he change in he overall produciviy disribuion briefly in he Inroducion (Figure 5a). As wih he wage disribuion here was a subsanial secular increase in produciviy inequaliy For example, comparing he 1984 o 1989 average wih he 1996 o 2001 average he differenial rose from 1.44 o Essenially, his is he main new sylized fac of he paper. Noe ha Figure 5a Whole Economy is he enire raw FAME daa before we exclude paricular indusries and size classes discussed in he daa secion. The paern is remarkably similar o Figure 5b manufacuring and services which is he sample afer hese selecions have been made. In addiion o he secular increase here is also an ineresing cyclical paern of produciviy dispersion. There was an increase in produciviy dispersion in he lae 1980s followed by a reducion during he recession of he early 1990s. Aferwards, produciviy dispersion coninued o increase unil a leas he year This paern is consisen wih he idea of he cleaning effec of recessions (e.g. Caballero and Hammour, 1994). The leas producive firms are more likely o exi an indusry (see he analysis of enry/exi in sub-secion 5.3 below) and his effec is likely o be 13

15 paricularly srong during cyclical downurns. Consequenly he produciviy disribuion is compressed due o a runcaion of he lef ail in he early 1990s. Noe ha his selecion effecs implies ha macro-economiss are probably underesimaing he degree of pro-cyclicaliy of produciviy over he business cycle. Increases in produciviy dispersion for he whole economy are largely driven by increases in privae services (see Figure 6). Produciviy dispersion across UK manufacuring firms has increased, bu o a much more limied exen (see Figure 7). The service secor also displays a sronger cyclical componen in he variaion of produciviy, decreasing very srongly in he early 1990s recession. Overall, we find ha he iner-firm produciviy disribuion has moved in a similar way o he iner-firm wage disribuion over he las weny years, suggesing ha he wo paerns may be linked. We explore his link in more deail in he nex sub-secion. 4.3 Decomposing rends in wage and produciviy inequaliy We firs consider decomposing he overall increase in individual wage inequaliy ino beween firm and wihin firm componens. We can furher sub-divide he beween firm componen ino a wihin and beween indusry componen. We use comparable NES and FAME samples o accomplish his, so we resric he NES sample in he same way we resriced he FAME sample (same indusries, boh male and female workers, boh par-ime and full-ime workers, ec.). Our decomposiion mehodology follows Davis and Haliwanger (1991) and Dunne e al. (2004). We use he NES daa o esimae he overall variaion of NES individual log wages denoed V ( W ), and he FAME daa o esimae he variance FAME of beween firm ln(wages) denoed V ( W ). The wihin firm componen denoed Vˆ WF, is hen he residual beween he wo series: 14

16 ˆ NES FAME WF V = V (W ) V ( W ) (1) Deails and furher discussion of he decomposiion mehodology are in Appendix A. Figure 8 conains he firs resuls of his decomposiion. The bold line shows he oal individual variaion of ln(wages) beween 1984 and 1999 which has increased by abou 16 log poins. This rend is well documened in several papers. The dashed line shows he beween componen (he iner-firm wage variaion) and he doed line he wihin firm componen (he difference beween overall wage dispersion and he beween firm dispersion) over he same period. Looking firs a he cross secion in he 1980s, abou half of he variaion in wages is aribuable o he variaion wihin firms and half is beween firms. The ineresing aspec, however, is in he ime series. The rend increase in beween-firm wage variaion is similar o he rend increase in he overall variaion of wages. In fac, he beween firm componen essenially accouns for jus abou all of he increase in he growh of aggregae inequaliy (he wihin firm increase rises a lile in he second half of he 1990s, bu is essenially fla). Figure 9 akes his one sage furher and decomposes he beween firm variaion ino a beween and wihin indusry componen. The beween indusry componen has risen, bu only by a minor amoun. In shor, he dominan reason for he increase in wage inequaliy appears o be he growh of inequaliy beween firms wihin indusries. This suggess ha examining how firms produciviy have changed over ime could help accoun for he changing wage disribuion as many of hese recen heories by Caselli and ohers have suggesed. Figures 10 hrough 13 show he breakdown beween manufacuring and services o illusrae, as before, ha he resuls are driven by he service secor. 15

17 We now urn o produciviy again. Since produciviy is a firm-level measure, we canno look wihin firms, so our decomposiions are ino wihin and beween indusry componens. We find a consisen picure ha he increase in produciviy inequaliy is a wihin indusry phenomenon (Figure 14). There is only a small increase in he produciviy dispersion beween indusries in services (Figure 15) and in manufacuring (Figure 16). One may be concerned ha he indusry decomposiions are based on wo digi secors and his is oo aggregaed. We replicaed he resuls on more finely disaggregaed indusries ha lead o similar qualiaive resuls Explaining he rising dispersion of produciviy Our key finding is ha here has been a secular increase in labor produciviy dispersion in he UK. We now seek o explain his by firs showing ha his is no simply due o an increase in dispersion of facor inpus (sub-secion 5.1), in ransiory shocks (sub-secion 5.2) or in enry/exi behaviour (sub-secion 5.3). We he presen some direc evidence in line wih he idea ha informaion echnology has an imporan role o play (sub-secion 5.4). We end wih some inernaional evidence (sub-secion 5.5) and some evidence on magniudes (sub-secion 5.6) Toal Facor Produciviy The main heories of wihin group wage inequaliy emphasise ha here has been some increase in he echnological heerogeneiy beween firms over ime. We would expec his o be refleced in differences in oal facor produciviy (TFP). Labor produciviy differences could arise from TFP differences, bu could also arise from increases in he dispersion of capial inensiy (fixed capial per worker) beween firms. Of course, some of his increased capial heerogeneiy could reflec 18 There is a rade-off here as he cell size per indusry year used o consruc he variance componens is obviously raher small when we go o more disaggregaed indusries. 16

18 experimenaion wih differen echnologies (such as ICT). However, we would sill expec some TFP differences (recall he discussion of Caselli s model in Secion 2). Theories of increased soring (e.g. Kremer and Maskin, 1996), by conras, do no have his implicaion. We can consruc TFP in a number of ways. The basic mehod is he difference beween weighed inpus and oupus. Measured TFP (MTFP) for firm j a ime is: MTFP = ln Q j α ln L j j ( 1 α j ) ln K j (2) Where Q j denoes value added, α j denoes he share of labor coss in oupu, L j denoes labor and K j denoes he capial sock. This is he simples mehod o compue TFP. There are more sophisicaed ways 19 o compue he parameers α j and o derive measures of TFP. We compue α j as firm specific weighs, i.e. α j is measured as he raio of oal wage bill over value added a he firm level and averaged over We sar wih analyzing he dispersion of capial inensiy (in Figure 17). Alhough his has indeed risen over he period, i canno fully accoun for he increase in he produciviy dispersion, as TFP has risen significanly over his period as well 19 Griffih e al. (2004) discuss he mehods common in he growh accouning lieraure. Direc esimaion of he producion by he mehods of iner alia Olley and Pakes (1996) and Blundell and Bond (1998) is anoher possibiliy. 20 We also compared his wih (i) imposing α j = 0.7, he ypically value for labor s share used in he lieraure on produciviy and (ii) esimaing α j as indusry specific weighs, i.e. α j measured as he raio of oal wage bill over value added a he wo or hree digi indusry level and averaged over he sample period. These produced similar resuls. 17

19 (see Figure 18). Comparing he evoluion of labor produciviy dispersion and TFP dispersion, we find ha he wo series follows each oher very closely 21. Since he soring models do no predic such as rise in TFP, we view his as giving some suppor for he echnology-based explanaions of Caselli (1999) and ohers Transiory Shocks Saisically, a rise in he cross secional dispersion of firm produciviy could arise purely from an increase in he ransiory produciviy shocks hiing firms 22. The environmen may have become more volaile for firms due o globalizaion, liberalizaion of produc markes and/or financial markes. Some analyses of lised US firms have claimed ha he variance of firms sales growh has increased over ime 23. Since produciviy ends o rise wih posiive demand shocks (see Figures 5a and 5b, for example), perhaps he increased variabiliy of firm-demand hen maybe his could accoun for he paerns in he daa. We analyze his hypohesis by looking a ransiion probabiliy marices of labor produciviy, TFP, wages and profis. Our objecive is o invesigae wheher increasing produciviy dispersion over ime simply reflecs increasing firm mobiliy across poins in he produciviy disribuion. We consider produciviy deciles and consruc ransiion probabiliy raes for he disribuions of labor produciviy over he years We compare ransiion probabiliy raes beween 1986/87 and 1988/89 (he early period ), beween 1992/93 and 1994/95 (he middle period ), 21 Ineresingly, beween-indusry effecs are slighly more imporan in explaining variaion in TFP han in labor produciviy. While hey explain 17% of he increase in labor produciviy dispersion, hey accoun for 25% of he variaion in TFP. 22 Dickens (2000) or Blundell and Preson (1998) are examples showing ha he increase in wage and income inequaliy are parially driven by increases in he ransiory componen. 23 See he debae beween Comin and Philippon (2005) and Davis e al (2006). 18

20 and beween 1998/99 and 2000/01 (he lae period ) 24. We pool he daa ino woyear blocks and compue he ransiion probabiliies beween adjacen blocks of years. For example, in he early period we pool daa for he same firms beween 1986 and 1987 o calculae he firm s posiion in he produciviy disribuion in, and hen do he same exercise for he firms in 1988 and 1989 (+1). We hen compare where firms in each decile of he disribuion in ended up in +1 (including he sae of exiing from he sample). I can be misleading o compare ransiion probabiliies raes a differen poins of he business cycle, because recession (expansion) years are characerised by an unusual number of firms exiing (enering) he marke. Given our way of shaping he daa, he early and lae periods correspond o a roughly similar posiion in he business cycle. The middle and lae 1980s were expansionary years as well as he middle and lae 1990s. The early 1990s were recession years. The resuls are summarized in Table 1 for he op and boom deciles (he full marices for labor produciviy are in Table 2) 25. We focus on he probabiliy ha a firm says in he same decile i began wih, and measure a decrease in his probabiliy as indicaing a rise in mobiliy. Unsurprisingly, firms ha sar in he op decile of he produciviy disribuion end o say here. In he early period, for example, 60% of firms who were in he op decile of he produciviy disribuion were sill in he op decile wo years laer. Similarly, 46% of he firms who began in he boom decile of he produciviy disribuion were sill here wo years laer (his underesimaes he persisence because he leas producive firms are disproporionaely likely o exi he daase as we show in Table 2). This is a much higher frequency han would be 24 We pooled daa in order o keep he cell sizes reasonably large for he decile analysis. Oher grouping lead o similar findings. 25 We condiion on he sub-sample of firms ha appear in wo consecuive years. 19

21 expeced by random flucuaions suggesing ha produciviy differences are persisen over ime. The key column for our purposes is column (4) of Table 1 ha compares he early and lae years (hese are a similar poins in he business cycle). There is a very small increase of firms a he boom of he produciviy disribuion moving up: only 45% of firms in he boom decile sayed here in he lae period, a one-percenage poin fall from he early period. Similarly, he mos producive firms were wo percenage poins less likely o say in he op decile in he lae period relaive o he early period (58% down from 60%). So mobiliy has increased, bu only by a small amoun. The nex rows of Table 1 perform he same exercise for TFP. For he leas producive firms, here is an increase in mobiliy beween he early and he lae period. In he lae period, 59% of he firms in he boom decile of he produciviy disribuion were sill here wo years laer (compared o 61% in he early period). However, he opposie is rue for firms a he op: hey show a decrease in mobiliy (50% up from 47%). As wih labor produciviy here is no sign of a large increase in mobiliy: alhough mobiliy raes have increased slighly for he boom decile by wo percenage poins, hey have declined a he op decile by hree percenage poins. We also invesigaed ransiions for average wages and produciviy. Looking a average wages, we find some increase in mobiliy beween he early and he lae period. This is rue for firms boh a he op (six percenage poins) and a he boom (four percenage poins) of he wage disribuion. This finding is no surprising and is also consisen wih he resuls obained by Dickens (2000) and Blundell and Preson (1998). Looking a average profis, we find an increase in mobiliy a he op only, 20

22 wih a decrease in mobiliy a he boom. The decrease a he boom (four percenage poins) ouweighs he increase a he op (wo percenage poins). Overall, hen i appears ha here is no evidence of a subsanial increase in he ransiory produciviy shocks facing firms, implying ha his is no he main explanaion for he increase in he cross-secional produciviy disribuion. Table 2 shows he ransiion marices in full deail. Because we have many small firms here is a lo of exi 26, especially for he leas producive firms. In he early period, for example, 30% of firms in he lowes produciviy decile exied compared o 20% in he highes produciviy decile. This paern of greaer exi probabiliy for he less producive firms is unsurprising as is he greaer level of exi during he middle period in he early 1990s when demand was low. This promps he quesion of wheher hese differenial exi and enry paerns explain he aggregae increase in produciviy dispersion Exi and Enry of Firms One possible explanaion of he rise in produciviy dispersion ha we observe could be ha here was a rise in produciviy dispersion among enrans. If enry barriers have declined due o liberalizaion or improved access o finance, for example, hen a wider variey of enrans could ener he marke wih higher levels of produciviy dispersion han previous cohors 27. In principle, incumbens could have no increase in dispersion. We analyse cohors of new enrans and incumbens for he early ( ), middle ( ) and lae ( ) periods. We hen look a he evoluion of 26 Noe ha exi includes exis o bankrupcy as well as exis due o akeovers. Takeovers are less likely o be a signal of under-performance han bankrupcy. 27 Of course, he ougher compeiion associaed wih lower enry barriers could reduce produciviy dispersion if he leas producive firms exi. Similarly, lower enry barriers may mean ha less efficien forward looking firms raionally choose no o ener assuming hey can observe heir produciviy in advance of enry. 21

23 he op half (90 h -50 h differenial) and he boom half (50 h -10 h differenial) of he labor produciviy disribuion. Table 3 shows ha enrans are indeed more dispersed in erms of produciviy han incumbens. In he early period, for insance, dispersion in he op half of he disribuion was 0.92 for enrans and 0.79 for incumbens. This paern has also been found in similar daases for oher counries. There has no been an increase in aggregae enry raes, however, so his finding by iself could no accoun for he increase in aggregae produciviy dispersion 28. Looking a changes in he produciviy dispersion of enrans beween he early and lae periods, we do see ha here has been an increase: he differenials have increased by seveneen log poins and hiry-one log poins in he op half and boom half, respecively. Neverheless, we also see an increase in he produciviy inequaliy of incumbens. Produciviy inequaliy for he op half has increased a a similar rae for enrans and incumbens (0.17 vs. 0.15). More ineresingly, he has increased faser for enrans (0.31 vs. 0.11). So his suggess ha increased heerogeneiy of enrans may have some role o play in accouning for he increase in lower ail (bu no upper ail) produciviy inequaliy. We also conduc a furher check in Table 4. We exclude all enrans and exiers, and we look a he evoluion of produciviy dispersion for wo balanced panels of coninuing firms (i.e. hose who were alive hroughou he period and hose who were alive hroughou he period ). We find ha here is an increase in produciviy dispersion even among coninuing firms, suggesing ha enrans are no he only cause of he rise in produciviy dispersion ha we observe wihin he economy. 28 The higher overall enry raes in he early period are due o he fac ha here was srong cyclical growh in he lae 1980s and much merger and acquisiion aciviy. 22

24 5.4. The role of Informaion and Communicaion Technology (ICT) in explaining he growh in produciviy dispersion wihin indusries In he previous secions we discussed and sysemaically eliminaed alernaive explanaions for he rise in produciviy dispersion wihin he UK economy (i.e., more soring beween firms, a rise in ransiory shocks, and a rise in produciviy dispersion among enrans). As a consequence, we consider echnical progress he mos likely cause and in his sub-secion, we direcly examine he role of ICT may have in explaining he growh in wihin-indusry produciviy dispersion. ICT informaion a he firm level does no exis for a long enough ime period o perform a micro-analysis (See Bloom, Sadun and Van Reenen, 2007, for a discussion). We can, however, evaluae he impac of ICT on wihin-indusry produciviy growh using he Bank of England Indusry Daase 29 (BEID) which conains informaion on ICT services, oal capial services, hours of work, oupu, value added, ec. a he wo-digi indusry level. We use FAME daa o compue he beween-firm dispersion of labor produciviy. We measure his as he differenial in log (real value added per employee) wihin each indusry and calculae he change beween and We regress his long-difference change in produciviy dispersion on he change in ICT inensiy and various conrols. The firs column of Table 5 simply presens he bivariae regression beween he change in produciviy dispersion and ICT inensiy revealing a large and saisically significan coefficien on ICT. A 10% increase in he share of ICT capial in oal capial services is associaed wih a 2.7% increase in he dispersion of labor produciviy. Column (2) includes a dummy for he manufacuring secor. As we 29 See Oulon and Srinivasan (2003). We hank Nick Oulon for making his daa available o us. 23

25 would expec given he earlier analysis, he dummy is significanly negaive indicaing ha even condiional on ICT he growh in produciviy dispersion is lower in manufacuring. Column (3) includes addiional conrols for he growh of oal capial services per hour, he growh of he proporion of workers wih college degrees and he change in union densiy (he proporion of workers who are members of rade unions). Including hese exra conrols reduces he magniude of he coefficien on ICT inensiy, bu i remains significan a he 5% level. The oher variables ake heir expeced signs. Capial inensiy is posiive and significan which is consisen wih he idea ha some echnology is embodied in non-ict capial. ICT capial growh could be reflecing he growh of skills, which is why we condiion on human capial he variable is posiive and significan. Insiuional explanaions of he rise in inequaliy emphasis ha union decline may allow low wage/low produciviy firms o survive. The union coefficien is indeed negaive bu i is insignificanly differen from zero. We were concerned ha he observed increase in dispersion may be due o he problem ha hours are no available a he firm level. Increased dispersion of produciviy could simply reflec increased dispersion of hours worked. To conrol for his we calculaed he dispersion of hours worked in each indusry using individual level daa from he NES (in column (4)) and he Labor Force Survey (in column (5)). These variables were boh insignifican and did no affec he coefficien on ICT inensiy. We also included oher demographic conrols (female workers and par-ime workers) as possible correlaes wih he increased use of ICT capial (and as facors ha could affec labor produciviy). Again, he ICT coefficien remains significan. In summary, afer conrolling for various facors, he posiive associaion beween increases in produciviy dispersion and changes in ICT inensiy sill holds. 24

26 The ICT variable is economically as well as saisically significan. ICT inensiy has grown very rapidly over his period (from 3.4% of all capial services in o 15% in ). Given he esimaed coefficien we can essenially accoun for all of he increase in produciviy dispersion (0.266 poins) by he increase in ICT inensiy Inernaional Daa If he growh of produciviy inequaliy was echnology based we would expec o observe his in oher counries. In paricular, France and Norway where here has been lile change in wage inequaliy (e.g. Machin and Van Reenen, 2007). Figure 19 shows us he siuaion in France beween 1989 and 2000 (we chose hese years because we have consisen daa). Ineresingly, like he UK, here has been a clear increase in he variaion of produciviy over his period. Noe, however, he y- axis scale is much narrower han in previous graphs. Produciviy has grown by abou 10% for firms a he 90 h decile and has fallen by 10% for firms a he lower decile. The median firm has experienced produciviy growh of abou 5%. This is in he same direcion as he UK, bu he rise in produciviy dispersion has been less dramaic. Figure 20 shows he siuaion in Norway in he period (he only period for which we have value added per worker informaion in non-manufacuring as well as manufacuring). There has been a small growh in he decile raio over his period. Ineresingly his increase is confined o he upper par of he 30 See Table A2. ln(ict services/capial services) increased by over his period so he implied effec is 0.37, more han 100% of he observed change. 25

27 disribuion (he 90-50); he lower half of he disribuion has shown some small decrease in inequaliy. I is well known ha inequaliy of wages in France and Norway has also grown more slowly han in he UK or US in he las 25 years. So alhough he increase in produciviy dispersion is no unique o he UK, i seems more mued in counries where here has been a slower growh of wage inequaliy. This suggess ha insiuional facors may play a role in he change of produciviy dispersion Quanificaion: How Imporan are he resuls for he wage disribuion? How imporan could he change in he srucure be in explaining he change in he wage disribuion? We have no ye wrien a formal general equilibrium model of he simulaneous deerminaion of he wage and produciviy disribuion 31 so all we can do is o give some inuiion over he magniudes. Appendix C gives a simple model ha could help us esimae some of he magniudes. The model assumes ha produciviy is driven by echnological facors and ha wages are deermined by a mixure of human capial characerisics and firm characerisics. Our model allows us o esimae he impac of he changing produciviy dispersion on wage dispersion as: Q var ln 2 L β (3) var(lnw ) Beween 1984 and 2001 he variance of ln(produciviy) rose by 0.26 and he variance of firm ln(wages) rose by If we assume ha β = 0.3 (e.g. Van Reenen, 1996) hen his implies ha 10% of he increase in he variance of iner-firm wages is accouned for by he variance of iner-firm produciviy. Therefore, his sill leaves a 31 See Klee and Korum (2004) or Lenz and Morensen (2005) for an aemp o do his in he cross secion. 26

28 big residual for such facors as he increase in he reurn o observable skills (and possibly increased soring). Neverheless, he increased produciviy dispersion is a significan par of he sory. Furhermore, here is some evidence ha he beween firm disribuion of produciviy could have become more imporan over ime in accouning for he wage dispersion. Running wage regressions separaely for differen ime periods reveals ha β has been increasing over ime. For example, Table 6 repors specificaions of a regression of wages on produciviy wih conrols for ime dummies and indusry effecs. We esimae separaely for an early period ( ), a middle period ( ) and a lae period ( ). The firs column repors simple OLS, he second column adds a full se of fixed effecs and he hird column repors GMM Sysem esimaes in he manner of Blundell and Bond (1998). All resuls show an increase in he imporance of he effec of produciviy on wage. For examples in he GMM esimaes he coefficien rises from in he mid 1980s o in he lae 1990s. This suggess ha firm heerogeneiy has become more imporan in explaining he overall wage disribuion. Alhough his shows ha firm heerogeneiy remains imporan for he wage disribuion, i is difficul o esimae how imporan his phenomenon is for he overall increase in inequaliy. As Appendix C shows, he effec will depend on such hard o measure hings as he variaion of human capial and he degree of workerfirm soring (and he changes in hese objecs). 6. Conclusions In his paper we have examined some evidence for he explanaion of he growh of residual wage inequaliy. We have shown ha a generally unesed 27