Trade Shocks, Firm Hierarchies and Wage Inequality

This study uses administrative employer-employee data and firm-level trade data from Denmark to provide evidence for a novel mechanism through which trade affects wage inequality: changes in firm hierarchies. This mechanism is motivated by the empirical fact that within-firm wage variation across the hierarchical levels of top manager, middle manager, supervisor and worker accounts for an important component of wage inequality. It is comparable in magnitude to wage differences across firms. To identify the causal effect of trade shocks on firm hierarchies and wage inequality, I use two distinct research designs for firm-level trade shocks—one based on foreign demand and transportation costs, and the other using the Muslim boycott of Danish exports after the Cartoon crisis. Both identification strategies suggest robust effects of trade shocks on within-firm inequality through changes in hierarchies. Consistent with models of knowledge-based or incentive-based hierarchies, firm-level trade shocks influence organizational choices through production scale. Adding a hierarchy layer significantly increases inequality within firms, ranging from 2% for the 50-10 wage gap to 4.7% for the 90-50 wage gap.