This 23-minute podcast was released Jan. 28, 2021.
“People that apparently work at the same jobs earn different [wages]. So, we think that how wages are negotiated and how firms set them will affect this residual wage dispersion. And that's what we are interested in trying to understand better in our research,” says Paulina Restrepo-Echavarria, senior economist at the Federal Reserve Bank of St. Louis. She talks with Shera Dalin, media relations coordinator at the St. Louis Fed, about why companies decide to list wages in job postings or bargain with job candidates instead.
More on this topic: Does Bargaining Help Explain Wage Inequality?
Shera Dalin: Welcome to Timely Topics, a podcast series by the St. Louis Fed. I'm Shera Dalin, your host for this episode. With me today is Paulina Restrepo-Echavarria, Senior Economist here at the Federal Reserve Bank of St. Louis.
Paulina Restrepo-Echavarria: Thank you so much for having me.
Dalin: Anyone who's searched online for a job has been mystified by why some companies list the wages or salary they'll pay and others don't. One of your most recent studies examined what factors affect a company's willingness to post wages in employee bargaining. It's a fascinating topic.
And I wanted to ask you, why are there such large differences in what people earn, even when you control for age, race, geography, and other factors?
Restrepo-Echavarria: So, yes, this is a very both interesting and important question in the literature. And it's a question that is still wide open in my opinion. We're still, you know, thinking about what the answers to it could be. And the literature up to now has offered different answers, including how people climb the job ladder, how they search on the job, and different reasons.
But today I'm going to be talking about one particular reason why there could be this such large differences in what people earn, even though you're controlling for observables, and that is how salaries or wages are set by firms.
So, whether a firm decides to post a wage and when you apply to the job, that wage is fixed and given, or whether a firm decides to open a vacancy, but the wage is supposed to be bargained when you match with the employer. We think that this has a potential to affect—this wage dispersion that we observe in the data, the residual wage dispersion, right, which is a dispersion that you will observe once you control for everything that you can quantify in some sense, right?
So, you can quantify age, race, education, and many other things. And we still see that people that apparently work at the same jobs earn different things. So, we think that how wages are negotiated and how firms set them will affect this residual wage dispersion. And that's what we are interested in trying to understand better in our research.
Dalin: That's a very good question to be looking at, especially these days. How does the cost of searching for a job, such as the time invested in writing a cover letter or filling out applications, and wage-setting affect hiring?
Restrepo-Echavarria: So, this is important because—I guess there are two dimensions to this question. One is in real life because we know that people, as you correctly said, spend time when they're searching for a job, right? They first look at the vacancy openings. Then they decide which ones they are going to be more interested in. In order to decide that, they have to acquire information about the type of job that each vacancy posting is offering. And then they have to do the whole process of filling applications, sending their resume to the firm, etc., etc.
Of course, how much effort they exert in this application process is going to affect where they end up being hired. So, one of the dimensions in our mathematical model is going to matter is the relative costs of search. Because, imagine that you, as a worker, face one cost of search. So, for example, different people are going to have different abilities to look for vacancy postings, for example. They're also going to have different abilities to fill in applications. They can be more convincing in their statements of purpose, etc.
And then on the other side of the market, you have firms, and those firms are also going to have differences in the search costs that they face. Imagine a small firm will not have a big human resources group, for example, trying to find candidates for them, but they will do it at a more personal level, or they will take a longer time than a very big company that has a huge human resources group.
Alternatively, they can also use headhunters. So, as you can see, the search costs for firms can be heterogenous, meaning that they're going to defer among them. The same thing for workers. And then the other thing that matters is the difference between the search costs for workers and firms.
So, what we're going to see in our research is that whether a firm faces a search post that is higher than a worker, or vice versa, it is going to have an important effect on the wage-setting mechanism that the firm is going to choose. So, that cost of searching is going to be key, basically, for our results.
Dalin: What does your research show about wage posting? What determines whether a firm lists a salary or bargains with job candidates?
Restrepo-Echavarria: So basically what we're going to see is that firms that face a higher search costs than workers are going to decide to post wages. So if a firm faces a high cost of searching for an employee, then they would rather post a given wage, which is going to depend on the position, right? So positions that are simpler or lower skilled are going to require lower wages, and they will post that wage, and then they would post higher wages for, let's say, managerial positions. And what that does is that when a worker or an employee is looking for a job, then they're going to observe a given wage, and they are going to self-select. So, this is the case when the search cost for the worker is lower.
So, they observed the vacancy. They know what the wage is. And so, given their skill set, they know what is the appropriate position that they should apply to in order to maximize the chance of getting hired by that firm. In the case where the search cost of the firm is lower than the search cost of the worker, then that's the case when the firm opts for bargaining, because they know that they can identify really well the type of a worker. They can really identify what are your skills, what you're good at, and what you're not so good at.
And so, in that case, then what they will do is that they won't post a wage. That will let, basically, everyone that is interested in applying for the job apply, and then they will bargain with them over the wage. At the end of the day, our model or our research says that firms that face higher search costs are going to prefer to post wages, and firms that face lower search costs relative to workers are going to decide to bargain.
Of course, the decision of whether to bargain or wage post is not necessarily the same for every single position that the firm has a vacancy for. Meaning that, as I mentioned before, if they're hiring for a managerial position, they can decide whether to bargain or wage post. And, if they are hiring a janitor, they can decide whether to bargain or wage post. And their decision is going to be different because they know that, even though the search cost of the firm is the same in general, more or less, for the two positions, they know that the search costs that the janitor versus someone from a managerial position faces are going to be different.
So what matters is the real elective search costs for a specific position and the skills that they want to fill the vacancy with, basically. And so that's how wage posting is going to be determined, by the relative search costs of workers and firms.
And the other dimension that I haven't mentioned before, which is also very important, is market tightness. Market tightness is the ratio of unemployed to the number of vacancies in the economy. So when the market is very tight, it means that there are very few workers available or looking for a job compared to the number of vacancies there are. And when market tightness is low, it means that there are a lot more employees or workers looking for a job.
So, what we observe is when it's harder to find a worker, when it's harder to fill your vacancy, firms, which is analogous to saying that market tightness is high, then firms are going to opt for bargaining, rather than post a vacancy because it's harder for them to find someone. They will opt to give a little bit more freedom to the wage-setting mechanism by bargaining rather than wage posting.
So, our research shows, basically, that they would post when search costs are high or when market tightness is low.
Dalin: So, if job hunters aren't seeing wages posted for employment openings, does that then tell them that the prospects in that job market are low?
Restrepo-Echavarria: So, no, not necessarily. If I'm going to answer that question, literally, given our model—if I answer from a mathematical standpoint, what it means is that, if you're looking for a job, and you don't observe a wage that is posted, in our model, it means that the worker knows that in expected terms, they're going to get 50% of the surface, meaning that if they find a job, if they match with this firm, they know that they are going to produce a certain amount, right? So, let's say that their output, right, is going to be 100, meaning that they go to their office; they sit down; they produce whatever they're supposed to produce; they use some of the capital of the firm in order to produce that something that is required by their position.
And the workers know, in the model, what that surplus is, and they know that they can expect to get 50% on average. And this is because if we take everyone that bargains, on average, you know, there are some people that are going to be better at bargaining so they're going to be able to bargain a wage where they get more than the firm out of what they produce, while there are some people that are not going to be as good at bargaining, so they're going to get less. So, on average, you know, they will just get 50%.
Now, that is in terms of the model, per se, right? It's not really in terms of real life. What happens in real life is that, if we don't observe a posted wage, then you're going to have to negotiate it, right? But I guess people in general have different indicators that do tell them, more or less, at the level that they're searching, how much they should be able to earn because, especially if you're moving in a lateral way, meaning that you're doing on-the-job search, then you know that a position that you're searching for has to be more or less at the level of the one that you have. You know how much you're earning right now, so your aim is to bargain, to earn at least what you're earning in your current position, or if you're unemployed, you want to earn at least your reservation wage, which is what you're "earning" when you're unemployed.
So, this is basically what they can infer when a firm is not posting a wage.
Dalin: We’ve talked here a good bit here about the availability of openings, but I want to talk just a little bit more about the bargaining aspect, because I think that's a fascinating topic, and I think it's one that people probably don't discuss as much because it can be very touchy. But I've heard career coaches say that job candidates should always negotiate for a higher wage when they're being offered a position. Does your research give you any insight into that approach?
Restrepo-Echavarria: So, yes, and no. In our model, if a wage is posted, you cannot negotiate it, right? It's given and you have to either decide to apply to that firm or not. Or actually you assign a probability of sending an application to that firm. So, that's going to be the mathematical part of the model.
However, career coaches are usually there for higher-skilled people. The people that do hire career coaches are usually high skilled. And what we see is that high-skilled people are much more prone to apply to positions where bargaining is available. So, for example, take CEOs. So the wage of a CEO is usually not posted. They might know around what level it is, but that's discussed in the hiring process. So the higher you are in the job ladder, then the likelihood of bargaining goes up. So in that sense, yes, what career coaches suggest is completely valid. You should always try to negotiate for a higher wage.
In our model let’s say, even though when your wage post, there's absolutely no chance of negotiating, and that does not apply. It does kick in when you have a higher skillset, and you are more likely to be in—or to apply to a bargaining position rather than to a wage posting position. So, that's kind of why I say that it's kind of a yes and no answer, meaning that, from a mathematical standpoint, if you observe a wage, that has to be your wage. But you're not very likely to be in that position given your skillset, and so you're more likely to bargain. And so, in that case, yes, this does apply to those higher-skilled people.
Dalin: That's very interesting, and, it's interesting the difference between what the mathematical model says versus the real-world experience of most people. You know I'm fascinated with your research on matching. You’ve said before that people who are trying to get something they want, whether it's a job or a mate, they fall into the trap of giving up too easily. So, what does that look like in the case of job searches with people giving up too easily?
Restrepo-Echavarria: It's a lot about acquiring information about the position that you are applying to. Just as in the dating market or the marriage market, when we've talked about this, the message is you need to search harder for a mate in order not to make a mistake. It's kind of the same with job searches. It's really important to understand what are the characteristics of the position that you are applying to.
When you as a worker observe vacancy postings, then you should try to exert as much effort as possible in order to fill that position. And that would be kind of our go-to answer to this question. You need to make as much effort as you can in order to find the right position for you.
However, in this line of research—these are very preliminary results—we're finding that people actually are making too much effort when it comes to searching for a job. And the difference between what we see when you are searching for a mate rather than for a job, and the fact that we're seeing people exerting too much effort when it comes to finding a job, is about the market structure or the order in which things happen.
So, when you're looking for a date or someone to marry, both men and women—or to the two sides of the market whoever they are—they are looking at the same time. So it's a simultaneous process. It's a simultaneous search.
When you are looking for a job, it's not simultaneous, but it's more sequential in the sense that the firm moves first. They post a vacancy. And you, as a worker, then decide where to apply when you have information about those vacancies that are open. And then the firm takes those applications that they received, and they look at them and then decide who to hire.
So, it seems like we are finding that from a mathematical standpoint, there is something that is implying that when the search is sequential rather than simultaneous, we observe that agents exert too much effort compared to the effort that a social planner would like them to exert. But we're still looking into this. This is a very preliminary result, but I think that it can potentially be fascinating because it can tell us a lot about how efficient or inefficient is the market.
Dalin: I'll be curious to see what your further research shows on that, because I think a lot of people would find it difficult to believe that they're putting too much effort into job searching, especially if they don't have a job in that moment.
Restrepo-Echavarria: Yes, exactly.
Dalin: And conversely, your advice has been, people need to search more to find that ideal mate.
Restrepo-Echavarria: Exactly. And that's why I say that I think it's something about the order in which things happen. When you're dating, it's kind of simultaneous. Everyone is in the lookout for someone else, right? And so you don't only look at applications, meaning you are not waiting for someone to show up at your doorstep in order to assess whether you're going to date them or not. But you are looking at yourself and trying to go to someone else's doorstep at the same time. While in a job search (it) is sequential, and it seems like from a mathematical standpoint, it clearly makes a difference. And so we're trying to understand more intuitively where is this coming from and why is there a big difference in that sense.
Dalin: So, I mean, obviously you're still working with the numbers and your model, but are there other interesting insights or something that surprised you that you'd like to share with us?
Restrepo-Echavarria: We're very excited about whether you should search harder or not because this has strong implications for efficiency. When a model delivers an efficient outcome, or an efficient equilibrium, it means that what agents decide to do by themselves is exactly the same that a social planner would tell them to do.
So, imagine that there was a god, and God can tell you exactly how you should act. And it turns out that you by yourself, without having God tell you what to do, you decide to do that by yourself. That, from a mathematical model standpoint, means that a model is efficient. And so, when those two equilibria don't coincide—meaning that if the equilibria kind of designed by a god, any given god, and the equilibria that you reach, or that you choose as an individual, is different—when those two are different, it means that there is an inefficiency in the market. There's something that is not working properly.
So, in the context of our specific model, what we've seen is that those two don't correspond, and it's related to what I was just talking about. It's related to the fact that we are seeing that when the search is sequential, it seems like individuals are searching too hard. And so, if this is the case, it means that the bargaining outcome might be an inefficient way for the market to operate, or vice versa. It could also be the wage posting. We're not sure, because we don't have those results.
So, imagine for a moment that—let's say that the wage posting is the one that is inefficient. If the wage posting is the one that is inefficient, we know that the residual wage dispersion that we are observing in the data, according to our model, is explained by all those firms that decide to bargain in certain positions.
This would mean, in principle, that bargaining is good for the economy. Wage posting not so much. And so, basically, the residual wage dispersion that we observe in the economy is an efficient outcome. It's a good thing. If it's the opposite, meaning that the bargaining, which is the one causing the residual wage dispersion is not that good, is not efficient, then we know that the residual wage dispersion is not efficient, which is what most people would just think is the case in general, right?
So, this dimension of whether, at the end, bargaining is efficient or is not efficient, is a very important question because it can potentially point us towards whether that residual wage dispersion that we observe is okay or it's not, because we as economists have spent so much time trying to explain where it's coming from, right? And in some sense we observe it as a negative feature of the data because we would all like everyone to earn the same, right? If you have the same characteristics, why are you earning a different wage? That shouldn't be okay.
This result would demystify that outcome, because it would tell us, well, no, it turns out that this residual wage dispersion that we are observing in the data is not that bad, is not negative. There's a reason why it's there, and it can actually be efficient. It can be an efficient outcome of markets.
So, I think that that's kind of like a question that I'm actually very much interested in trying to answer because now that we know from the first part of our research that, yes, whether a firm bargains or wage posts affects residual wage dispersion, now the next question is: But is that efficient or is that not efficient? Because, at the end of the day, how firms set wages can be changed. There could be policies that affect how firms set wages, and so we can potentially correct these inefficiencies in the market or come to the conclusion that dispersion in wages is actually a good thing.
Dalin: Very interesting. Well, Paulina, I've really enjoyed talking with you and learning more about your research. Thank you so much for sharing it with us. And we're looking forward to your next study and the other insights that you're going to unearth.
Restrepo-Echavarria: Thank you so much for having me. It was good to be here talking to you today.
Dalin: Thanks for joining us today.
Thank you for joining us.