Rasmus Lentz, University of Wisconsin-Madison

Labor Market Friction, Firm Heterogeneity, and Aggregate Employment and Productivity*
(joint w/ Dale T. Mortensen)

Abstract: The paper is based on a synthesis of a “product variety” version of the firm life cycle model developed by Klette and Kortum (2004) and an equilibrium search model of the labor market with job to job flows introduced by Mortensen (2003). In the construction, a final consumption good is produced from continuum of intermediate product and service varieties that are them- selves products of an aggregation of heterogenous labor inputs. Intermediate goods producers generally differ with respect to their productivity. New firms enter and continuing firms grow by developing new product varieties. The time required to match workers and jobs in the model depends on the total number of vacancies and possibly on the fraction of employed to unem- ployed worker. Workers receive job offers both while employed and unemployed. Wages are set through bargaining over marginal match surplus where the worker’s bargaining position may improve with the arrival of outside job opportunities as in Dey and Flinn (2005) and Cahuc et al. (2006). A job separation occurs if either a worker quits or a job is destroyed. We show that a general equilibrium solution to the model exists and that the equilibrium is broadly con- sistent with observed dispersion in firm productivity, wages, and the relationship between them as well as patterns of worker flows. The model implies that frictions, both in the labor market and in the firm growth process, can be important determinants of aggregate productivity as well as aggregate employment. The model delivers a wage dispersion decomposition into worker and firm side contributions as well as frictional dispersion that can itself be decomposed into bargaining position dispersion and idiosyncratic dispersion due to frictional labor force fluctu- ations. The model furthermore displays rich sorting patterns both between worker and firm types as well as between worker and coworker types. Inference is drawn from Danish matched employer-employee data.