Why Are Wages Smoother Than Productivity? An Industry-Level Analysis

In this paper we document a new fact about the cyclical behavior of productivity and wages. Using industry-level time series on wages and labor productivity, we show that in high-wage industries, wages respond relatively little to industry productivity shocks, whereas in low-wage industries, productivity movements result in a relatively large movements in wages. In other words, wages are substantially ”smoother” than productivity over time in high-wage industries, while wages are comparatively less smooth in low-wage industries. To explain this fact we develop a variant of the Thomas & Worrall (1988) wage contracting model. The two key features of our model are match-specific skills, which serve to increase wage smoothing in the contract, and exogenous match separations, which serve to reduce smoothing. We show that, empirically, a higher fraction of the skills of the high-wage workers are match-specific than the skills of low-wage workers, and that job separation rates are lower for high-wage workers than low-wage workers. A calibrated version of the model accounts quite well for the facts at hand.