Frictional Wage Dispersion in Search Models: A Quantitative Assessment

Abstract

Standard search and matching models of equilibrium unemployment, once properly calibrated, can generate only a small amount of frictional wage dispersion, i.e., wage differentials among ex-ante similar workers induced purely by search frictions. We derive this result for a specific measure of wage dispersion-the ratio between the average wage and the lowest (reservation) wage paid. We show that in a large class of search and matching models this statistic (the "mean-min ratio") can be obtained in closed form as a function of observable variables (i.e., the interest rate, the value of leisure, and statistics of labor market turnover). Various independent data sources suggest that actual residual wage dispersion (i.e., inequality among observationally similar workers) exceeds the model's prediction by a factor of 20. We discuss three extensions of the model (risk aversion, volatile wages during employment, and on-the-job search) and find that, in their simplest versions, they can improve its performance, but only modestly. We conclude that either frictions account for a tiny fraction of residual wage dispersion, or the standard model needs to be augmented to confront the data. In particular, the last generation of models with on-the-job search appears promising.

Applications and Interviews: A Structural Analysis of Two-Sided Simultaneous Search

“…Multiple causes underlie this result. First, limited wage dispersion is a standard finding in well calibrated search models of the labor market, as shown by Hornstein et al (2009). Second, the high value of home production restricts the amount of wage dispersion that can arise.…”

The Causal Effect of Unemployment Duration on Wages: Evidence from Unemployment Insurance Extensions

“…Our results are also consistent with structural estimates in van den Berg (1990) who found that most job offers are indeed accepted and that unemployed workers do not seem to reject many jobs based on wages. Similarly, Hornstein, Krusell, and Violante (2011) show that in broad classes of search models, the value of non market time -and hence the reservation wage -has to be low to be able to reconcile why despite high wage dispersion, and hence a high option value of searching, workers in practice accept jobs quickly. Following our approach, Lalive, Landais, and Zweimueller (2013) also find that the path of reemployment wages does not respond to increases in UI durations in Austria.…”

Uncertainty and Unemployment

“…It also predicts a quantitatively accurate size-wage differential. Hornstein, Krusell, and Violante (2011) reported that standard calibrations of searchand-matching models without on-the-job search cannot generate much dispersion in wages. In their basic calibration of a standard random search model, they obtained a mean-min ratio of 1.036 for wages, while their preferred empirical estimate is about 1.70 with a corresponding coefficient of variation of only 1/12th of the variation in the data.…”