Wages, Productivity, and the Dynamic Interaction of Businesses and Workers

This paper exploits a new matched universal and longitudinal employer-employee database at the US Census Bureau to empirically investigate the link between firms' choice of worker mix and the implied relationships between productivity and wages. We particularly focus on the decision making process of new firms and examine the role of both learning and selection. Our key empirical results are: (i) We find substantial and persistent differences in earnings per worker, output per worker, and worker mix across businesses within narrowly defined industries, which remain even after controlling for other observable characteristics. (ii) We find that new businesses exhibit even greater heterogeneity in earnings and productivity than do mature businesses, but that they adjust to the mature business pattern as they age. The adjustment process, while different for earnings and productivity, is consistent both with firms learning as they age and with the exit of mistake' prone firms. (iii) The dynamics of the reduction in productivity heterogeneity of new firms as they age is both complex and very different from the dynamic reduction of earnings heterogeneity.