Labor Market Complementarity: A Perspective on Inequality and Productivity Dynamics

Two salient changes in the US wage structure have occurred over the past three decades: first, a sharp increase in the wage premium to schooling despite a continual increase in the supply of schooling, and second, a rise and then fall of the wage premium to work experience. Capital-skill complementarity or skill-biased technological change may explain the first fact, but is silent on the second. Sector-specific experience or differential relative cohort size may explain the second fact, but not the first. We consider the complementarities across three attributes of human capital: raw labor, experience and schooling to reconcile both facts. Given such complementarities, changes in relative wages are due to the composition changes of these attributes of human capital. Using the PSID (1968-1997), we document a co-movement between the labor-experience ratio and experience premium, and also a co-movement between the experience-schooling ratio and the schooling premium. Compositional changes of these human capital attributes imply changes in labor productivity, which we relate to the "productivity puzzle" of the late 1970's to early 1990's. By estimating earnings equations implied by our theory, we measure the complementarity parameters across the human capital attributes. Constructing the actual work-experience measure from the work hours data in the PSID, and explicitly specifying the technology allows us to separate the experience, time and cohort effects. Using this strategy, we can identify inequality and productivity dynamics in the data