Economics Working Paper 19118
Abstract: Workers experience wage increases not only when they move across firms but also when they progress through a firm’s internal hierarchy of jobs. Workers who are promoted to higher-level jobs within a firm, typically after good performance, tend to enjoy further promotions and wage increases. Workers who are not promoted tend to instead experience negative changes in real wages, either because of the eroding effect of inflation on nominal wages or because of outright wage cuts. These features of careers are commonly interpreted as resulting from firms and workers learning about workers’ ability based on their performance and workers acquiring human capital through experience. To date, however, little is known about the relative importance of these two sources of wage growth and dispersion. Using administrative data on one firm first analyzed by Baker, Gibbs, and Holmström (1994a,b), I estimate a structural model in which firms and workers acquire information about workers’ ability and workers accumulate human capital when employed. The model fits well the rich patterns of job and wage mobility in the data. I find evidence for a key mechanism through which learning about ability shapes the dynamics of wages. Learning not only directly affects wages through the impact of current beliefs about ability on current wages but also indirectly affects them through promotions, by improving over time the sorting of workers to jobs according to their ability. Through this indirect effect, which is absent from existing empirical models of learning, I estimate that learning about ability is a crucial determinant of the growth and dispersion of individual wages.