Firms and wage inequality dynamics

Policies aimed at mitigating wage inequality, such as redistribution or access to services, frequently focus on workers. Fewer efforts are directed toward firms, despite their relevance for wage inequality dynamics.

This paper exploits a sharp reduction in Portuguese inequality over the last decades – driven exclusively by the compression of firm pay premiums – to pin down the role of firms in the evolution of wage inequality. Over the past two decades, Portugal witnessed a 20 percent decline in wage inequality (see panel A of the figure), almost single-handedly driven by firms (see panel b of the figure).

Coupled with rich microdata linking employees to their employer, this setting provides a unique opportunity to determine why and how firms drive the dynamics of wage dispersion. Results show that skill intensity (i.e. how skill intensive the tasks within each firm are on average) within the firm, followed by firm labor productivity, are the primary drivers behind the decline of firm pay premium dispersion witnessed in Portugal over the course of the last century. Furthermore, these effects come almost entirely from a decline in the return to these “good-firm” characteristics (a decline in passthrough). An increasing share of workers earning the minimum wage and a reduction in labor market concentration also contributed to the fall in between- firm pay premium dispersion but had smaller roles. Due to these effects wage inequality fell. This occurred despite an increase in within-firm wage inequality driven by technological adoption.

The findings suggest that understanding firms’ incentives and promoting policies that affect product market concentration and/or foster productivity and technology adoption for low-technology firms will be key for shaping inequality. These policies constitute an important complement to worker side polices focused on education, worker mobility and access to services.

Click here to go to the paper by Joana Silva, Jaime Montana, and Martim Leitão.