Wage Gaps Large and Small

[Author Affiliation]Barry T Hirsch, *Barry T. Hirsch is the W.J. Usery Chair of the American Workplace, Department of Economics, Andrew Young School of Policy Studies, Georgia State University, Atlanta, GA 30302-3992, and research fellow, IZA Bonn, Germany; bhirsch@gsu.eduThis presidential address was presented at the Annual Meeting of the Southern Economic Association, New Orleans, LA, on November 20, 2007.[Acknowledgment]I thank the many economists with whom I have interacted or coauthored over the years, in particular, John Addison, Chris Bollinger, Bill Breit, Bill Johnson, Dave Macpherson, and Ed Schumacher.Barry T. Hirsch, W.J. Usery Chair of the American Workplace, Department of Economics, Andrew Young School of Policy Studies, Georgia State University 2007 President of the Southern Economic Association (Figure omitted. See article image.)1. IntroductionIn the Wealth of Nations, Adam Smith posited theory and institutional explanations for why wages differ. Modern labor economics has retained a focus on wage differentials. Although much of the literature is unabashedly empirical, it is informed by theory. Neoclassical economics, including human capital theory, remains the principal approach, although labor economists recognize the role played by human nature, workplace incentives, institutions, and public policy in wage determination.In this address, I highlight several topics I have studied, all involving wage gaps.1 These include Census imputation methods, union premiums, product market regulation, wages in male and female jobs, the wage effects of military service, and interarea wages and cost of living. The purpose is not to trumpet my work, although it may appear as such, but to draw broader conclusions about labor economists' understanding of wage determination.2. Equalizing Differentials and the Law of One WageThe theory of equalizing differentials states that in competitive labor markets, workers with similar skills working in similarly attractive jobs and locations should receive similar compensation. Long-run wage differentials are explained by differences in skill and job disamenities, with a single "price" (wage) conditional on worker and job attributes.2 The law of one wage--equal compensation for equivalent workers and jobs--follows naturally from competitive theory.Empirical studies attempt to test the law of one price in product markets. Industrial organization economists focus on a narrow set of homogeneous goods in markets with low-cost information and similar transportation costs, i.e., purchases of electronics and books at Internet sites. International economists test for purchasing power parity for homogeneous goods, i.e., Big Mac prices across countries (for a recent paper, see Parsley and Wei 2007). Even in these markets, there is considerable deviation from the law of one price.One does not see an equivalent literature in labor economics. Yes, there is a vast literature on wage gaps, but authors rarely characterize such work as a test of a "law of one wage" because there is little expectation that there should be wage equality, even conditional on controls. Why not? First, as emphasized in personnel economics, pay schemes that maximize profits often involve wages deviating from spot marginal products, thus creating competitive wage differences across similar workers in similar jobs (Lazear and Oyer 2007). Second, unions or other institutions can affect wages. Third, there are rigidities in labor markets owing to imperfect mobility, say from information and search costs, firm-specific training, personal job attachment, or tied household decisions regarding jobs, location, and housing (Manning 2003; Mortensen 2003). Fourth are problems of measurement, leading to apparent variation in wages even when there is none. And fifth, even if data are error free, we cannot hope to measure all the multitude of worker and job attributes that influence wages. …