Economists and other social scientists have spent years focused almost solely on changes in the attributes of workers in their efforts to understand rising inequality in the United States, examining workers’ ages, education levels, occupations, and union status. More recently, however, economists have set their eyes on the firm as a major source of income inequality.
Recent research on what’s known in economics as “interfirm inequality” shows that differences in wages across firms can explain why workers who appear to be very similar based on their worker attributes can end up being paid very different salaries. Economists’ estimates of the role of interfirm inequality put it at about two-thirds of the overall increase in income inequality. Yet new research highlights another way that firms affect workers’ incomes. Employers affect their workers’ earnings not only now, but into the future as well.
The new paper by economists John M. Abowd of Cornell University and the U.S. Census Bureau, Kevin L. McKinney of Census, and Nellie L. Zhao of Cornell looks at the current wage effect of firms and how a current employer results in higher or lower future wages for workers. To understand their findings, think of the U.S. labor market as a series of ladders, with firms being different ladders and wage levels corresponding to rungs on the ladders. A strong firm effect means that similar workers end up on different rungs of their respective firm ladders. The authors of this paper find that firms can also change the rate at which workers are climbing up their ladders.
Consider three workers who fall into the middle of the skill distribution (skill being the return on things that economists can’t observe in the data) and the wage distribution. Each worker gets put on a different ladder, representing each working for different firms. These employees not only get placed at different rungs on the ladders due to differences in how the firms pay, but also climb up the ladders at different rates.
The first worker, who’s employed by a low-wage firm, has less than a 1 percent chance of getting to the top fifth of his or her firm’s ladder. The second worker, employed at a medium-wage firm, has about a 3 percent chance of getting to the top 20 percent of the rungs. But a worker at a high-wage firm has an almost 12 percent chance of getting near the top of the ladder. The probability of moving up is also better for high-skilled workers at high-wage firms—about 33 percent. This compares to the roughly 5 percent and 14.5 percent chances at low- and medium-wage firms, respectively, for high-skilled workers.
As Peter Orzsag points out at Bloomberg View while writing about this research, policymakers have ignored the importance of what’s going on inside firms for far too long. Concerns about firm behavior often coalesce around its effect on prices. But in an era of increasing business consolidation and seemingly increased market power, policymakers should also be aware of the ability of firms to impact workers’ ascent up an already-rickety job ladder.