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Stepping Off the Wage Escalator: The Effects of Wage Growth on Equilibrium Employment


  • Michael W. L. Elsby
  • Matthew D. Shapiro


This paper emphasizes the role of wage growth in shaping work incentives. It provides an analytical framework for labor supply in the presence of a return to labor market experience and aggregate productivity growth. A key finding of the theory is that there is an interaction between these two forms of wage growth that explains why aggregate productivity growth can affect employment rates in steady state. The model thus speaks to an enduring puzzle in macroeconomics by uncovering a channel from the declines in trend aggregate wage growth that accompanied the productivity slowdown of the 1970s to persistent declines in employment. The paper also shows that the return to experience for high school dropouts has fallen substantially since the 1970s, which further contributes to the secular decline in employment rates. Taken together, the mechanisms identified in the paper can account for all of the increase in nonemployment among white male high school dropouts from 1968 to 2006. For all white males, it accounts for approximately one half of the increase in the aggregate nonemployment rate over the same period.

Suggested Citation

  • Michael W. L. Elsby & Matthew D. Shapiro, 2009. "Stepping Off the Wage Escalator: The Effects of Wage Growth on Equilibrium Employment," NBER Working Papers 15117, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:15117
    Note: EFG LS ME PR

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    References listed on IDEAS

    1. Layard, Richard & Nickell, Stephen & Jackman, Richard, 2005. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780199279173.
    2. Lee, Chul-In, 2008. "On-the-job human capital investment and intertemporal substitution: New evidence on intertemporal substitution elasticity," Journal of Economic Dynamics and Control, Elsevier, vol. 32(10), pages 3350-3375, October.
    3. Blinder, Alan S & Weiss, Yoram, 1976. "Human Capital and Labor Supply: A Synthesis," Journal of Political Economy, University of Chicago Press, vol. 84(3), pages 449-472, June.
    4. Shaw, Kathryn L, 1989. "Life-Cycle Labor Supply with Human Capital Accumulation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(2), pages 431-456, May.
    5. Brooks Pierce, 2001. "Compensation Inequality," The Quarterly Journal of Economics, Oxford University Press, vol. 116(4), pages 1493-1525.
    6. Smith, James P & Welch, Finis R, 1989. "Black Economic Progress after Myrdal," Journal of Economic Literature, American Economic Association, vol. 27(2), pages 519-564, June.
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    More about this item

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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