Tuesday, 23 August 2016

Wage segregation, asymmetric information and inequality

Samuel Hammond wrote a post for the Niskanen Center blog that might be one of the clearest and most insightful blog posts I've ever read. Hammond writes about increasing wage segregation in the U.S. labour market, but the insightful bit is to link it to reductions in information asymmetry between employers and workers. I'll refrain from wholesale copying-and-pasting most of the post, which you should read! Here is the most important bit:
How does this apply to technological change, wages, and inequality?
Think back to the naive insurer attempting to “pool” high and low risk types under one premium. Now substitute insurer with employer, and high and low risk types with low and high productivity workers, and the flat premium with a relatively flat wage structure.
Our nostalgic vision of the mid-20th century’s strong middle class is a memory of a wage pooling equilibrium that eventually unraveled. Behemoth corporate employers priced labor in a relatively naive way, given an inability to observe the heterogeneity of individual productivity moment by moment, and the role of labor unions in negotiating wages as a collective. While there was still a premium on things like seniority and higher education, wages were nevertheless fairly compressed.
For workers who contributed substantially more value to the company than they were being paid for, this was a raw deal. Conversely, it was great deal for workers whose productivity lagged. In other words, high productivity workers bore a negative externality by having to partially subsidize low productivity workers due to the inherent opacity of who-contributes-what within team production.
That has changed with information technology that makes it easier than ever to observe and measure individual worker productivity and screen for it accordingly (which may be why the premium from working at larger firms has also diminished).
Wage segregation is of course important because it is one of the causes of the recent increase in inequality observed in the U.S. The previous pooling equilibrium led both high and low productivity workers to have roughly the same wages, because it was difficult for employers to tell them apart. With the (technological) ability to more closely monitor and measure worker performance, the high and low productivity workers can be separated, allowing firms to reward the high productivity workers with higher wages (and not reward low productivity workers).

Now, having said all that it makes me wonder - why isn't inequality increasing in New Zealand for the same reason? As Eric Crampton has noted many times, inequality has barely changed in New Zealand since the mid-1990s. Surely we must have wage segregation here as well? What gives?


  1. Very interesting perspective. I have not read the original blog post but a few questions come to my mind. The pay at the very top especially in banking and finance has often been singled out as one of the main drivers of inequality. Is it that it is now very possible to 'closely monitor and measure worker performance' for those at the very top in the banking industry vs other industries? Are bankers being rewarded for their stellar performance? Is this 'wage segregation and measuring of workers performance effect' working across the whole pay distribution or for those at the top especially since we are seeing the top pull away?

    1. I'm not sure about banking specifically. I do recommend reading the blog post I linked to, and you might find it instructive to read the Song et al. paper linked from there. The key point is that wage segregation is about between-firm wage variance being a greater contributor to wage inequality than within-firm wage variance. Perhaps I could have made this clearer in my post. It essentially means that firms are becoming more specialised in employing high-productivity high-wage workers, or lower-productivity lower-wage workers. And the ability to separate the high productivity and lower-productivity workers is the key to that.