ABSTRACT

Studies of individual wage dynamics typically ignore firm heterogeneity, whereas decompositions of earnings into worker and firm effects abstract from life-cycle considerations.
We study firm effects in individual wage dynamics using administrative data on the population of Italian employers and employees. We propose a novel identification strategy for firm-related
wage components exploiting the informative content of the wage covariance structure of coworkers. Wage inequality increases three-fold over the working life; firm effects are predominant while young, but sorting of workers into firms becomes increasingly important, explaining the largest share of lifetime inequality. Static models that do not allow for life-cycle dynamics underestimate the importance of sorting and overstate match and firm effects.

Keywords: Wage inequality, Wage dynamics, Co-workers’ covariance.
JEL Codes: J24, J31.
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