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Wage Changes, Establishment Growth, and the Effect of Composition Bias

  • Monica Galizzi
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    The correlation between real wages and aggregate employment growth has beenthe object of several empirical studies conducted with both aggregate and micro data.Despite the new availability of linked employer-employee data, however, we still havelimited empirical evidence [Belzil, 2000] to describe how real wage cyclicality can beexplained by what happens between workers and employers at the firm level. Thispaper makes a contribution by making use of Italian data to explore whether a posi-tive relationship between wage growth and employment growth is induced mainly byan establishment effect or by an industry effect, at least as long as these effects aremeasured in terms of employment changes.As in the case of wage cyclicality studies, this research takes into account theconsequences that a composition effect can have on the factors that affect the employeeearnings in each establishment. When a firm is growing, as well as in the growthphase of a cycle, new workers enter the job market. They are traditionally low-skillemployees or young people or previously “discouraged” workers. They earn low wages,and so lower the average wage in the firm. This can explain the negative or insignifi-cant correlation between real wages and employment level that has been found inseveral studies conducted at the aggregate level. For the first time, this study teststhe existence of a composition bias with firm-level data where both employment andwage growth can be measured for each establishment. Checking whether employ-ment growth, within firms and within sectors, differently affects the change in thefirm’s average wage or the mean of the individual wage changes does this.This research makes use of 1981-83 records for a sample of Italian firms. Informa-tion about each establishment is combined with information about its employees. Thestudy explores cases in which firms are experiencing an employment decline, an employ-ment increase, or no more than the national rate of labor turnover. The same analy-sis is conducted for categories of workers that, within the same firm, differ because ofjob qualifications or gender.The paper is organized as follows: part 2 presents some of the theories concerningthe relationship between wage changes and employment growth. It also illustratesthe problem of a possible composition bias. Part 3 presents the empirical framework.Part 4 describes the data set used for the estimations. Part 5 discusses the results.The conclusions summarize the major findings.

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    Paper provided by LABORatorio R. Revelli, Centre for Employment Studies in its series LABORatorio R. Revelli Working Papers Series with number 64.

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    Length: 22 pages
    Date of creation: 2007
    Date of revision:
    Handle: RePEc:cca:wplabo:64
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    1. Hildreth, Andrew K G & Oswald, Andrew J, 1997. "Rent-Sharing and Wages: Evidence from Company and Establishment Panels," Journal of Labor Economics, University of Chicago Press, vol. 15(2), pages 318-37, April.
    2. Jacobson, Louis S & LaLonde, Robert J & Sullivan, Daniel G, 1993. "Earnings Losses of Displaced Workers," American Economic Review, American Economic Association, vol. 83(4), pages 685-709, September.
    3. John M. Abowd & Francis Kramarz & David N. Margolis, 1994. "High Wage Workers and High Wage Firms," NBER Working Papers 4917, National Bureau of Economic Research, Inc.
    4. Brown, James N, 1989. "Why Do Wages Increase with Tenure? On-the-Job Training and Life-Cycle Wage Growth Observed within Firms," American Economic Review, American Economic Association, vol. 79(5), pages 971-91, December.
    5. John C. Haltiwanger, 1997. "Measuring and analyzing aggregate fluctuations: the importance of building from microeconomic evidence," Review, Federal Reserve Bank of St. Louis, issue May, pages 55-78.
    6. Krueger, Alan B & Summers, Lawrence H, 1988. "Efficiency Wages and the Inter-industry Wage Structure," Econometrica, Econometric Society, vol. 56(2), pages 259-93, March.
    7. Gary Solon & Robert Barsky & Jonathan A. Parker, 1992. "Measuring the Cyclicality of Real Wages: How Important is Composition Bias," NBER Working Papers 4202, National Bureau of Economic Research, Inc.
    8. Katharine G. Abraham & John C. Haltiwanger, 1995. "Real Wages and the Business Cycle," Journal of Economic Literature, American Economic Association, vol. 33(3), pages 1215-1264, September.
    9. Nickell, S. & Wadhwani, S., 1989. "Insider Forces And Wage Determination," Economics Series Working Papers 9972, University of Oxford, Department of Economics.
    10. Galizzi, Monica & Lang, Kevin, 1998. "Relative Wages, Wage Growth, and Quit Behavior," Journal of Labor Economics, University of Chicago Press, vol. 16(2), pages 367-91, April.
    11. Levine, David I, 1992. "Can Wage Increases Pay for Themselves? Tests with a Production Function," Economic Journal, Royal Economic Society, vol. 102(414), pages 1102-15, September.
    12. Geary, Patrick T & Kennan, John, 1982. "The Employment-Real Wage Relationship: An International Study," Journal of Political Economy, University of Chicago Press, vol. 90(4), pages 854-71, August.
    13. Brunello, G. & Wadhwani, S., 1989. "The Determinants Of Wage Flexibility In Japan: Some Lessons From A Comparison With The Uk Using Micro-Data," Papers 362, London School of Economics - Centre for Labour Economics.
    14. Charles Brown & James L. Medoff, 1989. "The Employer Size-Wage Effect," NBER Working Papers 2870, National Bureau of Economic Research, Inc.
    15. Bils, Mark J, 1985. "Real Wages over the Business Cycle: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, vol. 93(4), pages 666-89, August.
    16. Belzil, Christian, 2000. "Job Creation and Job Destruction, Worker Reallocation, and Wages," Journal of Labor Economics, University of Chicago Press, vol. 18(2), pages 183-203, April.
    17. William T. Dickens & Lawrence F. Katz, 1986. "Interindustry Wage Differences and Industry Characteristics," NBER Working Papers 2014, National Bureau of Economic Research, Inc.
    18. Assar Lindbeck & Dennis J. Snower, 2001. "Insiders versus Outsiders," Journal of Economic Perspectives, American Economic Association, vol. 15(1), pages 165-188, Winter.
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