Heterogeneous Passthrough from TFP to Wages

In this paper, we use matched employer-employee data from Denmark to analyze the extent to which firms’ productivity shocks are passed to workers wages. The richness of our dataset allows us to separately study continuing and non-continuing workers (switchers), to correct for selection, and to investigate how the passthrough varies across narrow population groups. Our results show a much larger degree of passthrough from firms’ shocks to workers’ wages than reported in previous research. On average, an increase of one standard deviation in firm-level TFP commands an increase of 3.0% in annual wages ($1500 USD for the average worker). Furthermore, we find that the effect of productivity shocks on wage growth for switchers is of larger magnitude relative to workers that stay in the same firm. Finally, we find large differences in the passthrough of productivity shocks to wages for workers of different income levels, ages, industries, and working in firms of different productivity levels. In the second part of our paper, we estimate a stochastic process of income that captures the salient features of the relation between firm-level shocks and the passthrough to workers' wages. We then embed the estimated stochastic process into a life-cycle consumption savings model with incomplete markets in order to evaluate the welfare and distributional implications of the passthrough from firm's TFP shocks to worker's wages we observe in the data.