Job Search, Human Capital and Wage Inequality

The objective of this paper is to construct and quantitatively assess an equilibrium search model with on-the-job search and human capital accumulation. In the model workers enter the labour market with different abilities and firms differ in their labour productivities. Wages are disperse because of search frictions (firms pay workers of the same productivity different wages) and workers' productivity differentials (workers of different productivities earn different wages). Further, there is positive sorting between workers and firms and this increases wage dispersion. The model generates a simple (log) wage variance decomposition that is used to measure the importance of productivity differentials, search frictions and sorting dynamics between workers and firms. I calibrate the model to match spell durations and wage variation of a (relative) homogeneous sample of workers using UK household level data. I show that wage variation due to productivity difference explains around 60 percent, search frictions around 25 percent and sorting dynamics the remainder 15 percent. The model is then used to analyse the average wage-experience profile of workers and shows the importance of human capital accumulation in shaping such a profile.