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Beyond BLS

Beyond BLS briefly summarizes articles, reports, working papers, and other works published outside BLS on broad topics of interest to MLR readers.

March 2023

Earnings inequality has increased across newer firms

Summary written by: Lisa N. Huynh

As income inequality has become more prevalent throughout the economy, two trends help explain why labor market outcomes have varied across firms in the United States over the last several decades. First, earnings inequality has mainly increased because of the rising between-firm pay dispersion. Second, business dynamism and firm entry rates have decreased simultaneously, which shifted employment toward older firms. In “The slow diffusion of earnings inequality” (National Bureau of Economic Research, Working Paper 30977, February 2023), authors Isaac Sorkin and Melanie Wallskog analyze how these trends affect labor market outcomes, which differ across cohorts of firms and the life cycle of firms.

Using data from the U.S. Census Bureau, Sorkin and Wallskog identify that newer cohorts of firms show greater between-firm earnings inequality compared with older firm cohorts. These trends, increased inequality and decreased business dynamism (mentioned above), have diffused slowly as more cohorts of firms enter the labor market. The authors also use data from the Longitudinal Employer Household Dynamics dataset and the Longitudinal Business Database, which contain matched employer–employee data and dates of firm entry, respectively. These data also confirm that the level of between-firm earnings inequality of new firm cohorts is higher than that of older cohorts, before slowly declining as previous cohorts have over time.

Sorkin and Wallskog then analyze the role of time and cohort effects by separately identifying age, year, and cohort effects between newer and older firms. This analysis confirms the findings just mentioned but also discovers that newer firm cohorts have different qualities than older ones. These newer cohorts are more dispersed in pay and productivity. In addition, because business dynamics have changed, the age distribution of firms has shifted; share of employment is higher among older firms. As for the rise of between-firm earnings inequality of newer cohorts, the authors attribute factors such as “outsourcing, skill-biased technical change, or deunionization.” Instead of these factors occurring to all firms simultaneously, they slowly diffuse across the newer cohorts.

Sorkin and Wallskog’s analysis helped them identify the trends of the labor market to explain the increase of earnings inequality. On the basis of this explanation, the authors conclude that even if technology remains equal or does not change over time, subsequent firms entering the market will continue to affect the between-firm earnings inequality and attribute to the gap in earnings within the economy.