Ebook Asymmetric information, wage dispersion and unemployment fluctuations
It has been widely acknowledged that the standard matching model introduced by Mortensen and Pissarides (1994) or Pissarides (2000) adequately explains how the labor market functions. This model does however involve at least two major problems. First, unemployment and vacancies are as volatile as labor productivity yet the aggregate data reveals that these numbers are much higher by a factor of 10. Second, an inspection of various micro databases reveals that mean wage is at least twice as high as minimum wage, yet the basic model predicts they should be approximately equal. In inequality literature, this particular measure, also known as the mean-to-min ratio, has not acquired its popularity but proves to be the most relevant wage dispersion measure because the worker’s outside option determines the lowest wage paid while the average wage can easily be computed as wage generally follows a particular distribution function.
Why do policymakers care about unemployment volatility and wage dispersion? It is well known that the former affects the determination of employment; depreciates human capital; causes productive and social externalities; and job loss, often associated with major source of income risk to individuals. The later, as Mortensen (2003) reminds us, is a major source of wage difference among workers with similar characteristics such as education, experience, race, gender, etc.; reflects differences in marginal productivity of labor across employers rather than workers; and makes it easier to understand the efficiency of the process by which workers are allocated to jobs.
My contribution to the literature on unemployment volatility and wage dispersion is straightforward. First, I develop the take-it-or-leave-it offers within the two-side asymmetric environment introduced by Delacroix and Wasmer (2006). The authors make use of this mechanism to differentiate destinations for worker outflows from employment, the quit and layoff to unemployment and the job-to-job flows. My model differs from theirs in the following characteristics: neither on-the-job search nor firing costs nor investment in human capital is designed for the model. Second, I investigate whether asymmetric information could solve both puzzles. Third, the model generates endogenous wage distributions while most studies on matching models impose one that is exogenous. I conclude that asymmetric information effectively amplifies wage dispersion, but it fails to enhance unemployment fluctuations. The first result is new and positive, while the second (negative) is consistent with the findings of Guerrieri (2007) and Br¨ugemann and Moscarini (2008) on the inability of asymmetric information to generate realistic levels of volatility.
The take-it-or-leave-it offers mechanism is much more intuitive than that of Nash, but how exactly it is able to successfully solve the wage dispersion puzzle and why it is not able to solve the unemployment volatility puzzle? The answer is very simple. In possessing private information both firms and workers will make only modest wage offers to avoid separation, a mechanism that increases the mean-to-min ratio. When aggregate productivity increases, low productivity firms make more generous offers than those with high productivity, while high amenity workers require more than the low ones. Average wage consequently closely follows aggregate productivity, implying little job creation. Hence, the model’s mechanism would not be able to solve both puzzles at once.
To facilitate numerous calculation steps, I assume both workers’ and employers’ idiosyncratic shocks take the exponential distribution form. I then calibrate the model’s parameters to match the standard shapes for wage distribution and two types of separation (the quit and layoff to unemployment flows) shown in the IPUMS-CPS data. I show the model’s results when substituting various unemployment benefit values employed in the literature. Unlike the literature, I find that unemployment benefits play only a small role in amplifying unemployment fluctuations and wage dispersion. I explain the reasons for the results my model obtained by examining how wage offers respond to changes in labor productivity and to changes in unemployment benefits.
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