Wage Inequality as a Source of Endogenous Macroeconomic Fluctuations

There is extensive evidence on both the endogeneity of labor productivity to the wage remuneration and the persistence of wage inequality across observationally similar workers and firms. The paper builds an evolutionary micro-dynamic model having these two features of the labor market as interconnected, and explores the ensuing implications for the macro-dynamics of the distribution of income, capacity utilization and output growth. Firms periodically revise (and possibly switch) their choice of remunerating workers with a higher or lower wage, and the resulting labor productivity differential across workers is endogenous to the distribution of wage remuneration strategies across firms. The long run features wage inequality as a persistent outcome. Moreover, plausibly low levels of wage inequality suffice to cause the distribution of wage remuneration strategies across firms, and therefore the distribution of income, capacity utilization and output growth, all to experience self-sustaining cyclical fluctuations.