Kory Kantenga

We measure the roles of the permanent component of worker and firm productivities, complementarities between them, search frictions, and equilibrium sorting in driving German wage dispersion. We do this using a standard assortative matching model with on-the-job search. The model is identified and estimated using matched employer-employee data on wages and labor market transitions without imposing parametric restrictions on the production technology. The model's fit to the wage data is comparable to prominent wage regressions with additive worker and firm fixed effects that use many more degrees of freedom. Moreover, we propose a direct test that rejects the restrictions underlying the additive specification. We use the model to decompose the rise in German wage dispersion between the 1990s and the 2000s. We find that changes in the production function and the induced changes in equilibrium sorting patterns account for virtually all the rise in the observed wage dispersion. Search frictions are an important determinant of the level of wage dispersion but have had little impact on its rise over time.

The paper uses a combination of micro-level datasets to document the rise of income polarization—what some have referred to as the “hollowing out” of the income distribution—in the United States, since the 1970s. While in the initial decades more middle-income households moved up, rather than down, the income ladder, since the turn of the current century, most of polarization has been towards lower incomes. This result is striking and in contrast with findings of other recent contributions. In addition, the paper finds evidence that, after conditioning on income and household characteristics, the marginal propensity to consume from permanent changes in income has somewhat fallen in recent years. We assess the potential impacts of these trends on private consumption. During 1998-2013, the rise in income polarization and lower marginal propensity to consume have suppressed the level of real consumption at the aggregate level, by about 3.5 percent—equivalent to more than one year of consumption.