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Frictional Labor Markets, Education Choices and Wage Inequality

Manuel Macera and Hitoshi Tsujiyama
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Hitoshi Tsujiyama: Goethe University Frankfurt

No 827, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies how education choices and labor market frictions interact in shaping wage inequality. The wage premium of college graduates relative to high school graduates (between-group inequality) has tripled since 1980 in the U.S., and the variance of log wages conditional on educational attainments (within-group inequality) has become about 50% larger across the board. To understand the source of this change, we construct a model with schooling investments and labor market frictions that generates supply and demand of skills and frictional wage differentials as equilibrium objects. The model features a two-sided sorting: education sorting of skilled workers into college education and labor market sorting of productive firms into the labor market for college graduates − together implying an assortative matching of high skilled workers to productive firms. A novel model-based wage decomposition of both the between- and within-group inequalities is obtained. Calibrating the model to the U.S. data, we find that the inequality trend is accounted for by worker composition and labor market friction. If there were no skill- biased technological change, the variance of log wages would be smaller, mainly due to lower within-group inequality.

Date: 2018
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