Top income inequality in the United States has increased considerably within occupations. This phenomenon has led to a search for a common explanation. We instead develop a theory where increases in income inequality originating within a few occupations can 'spill over' through consumption into others. We show theoretically that such spillovers occur when an occupation provides non divisible services to consumers, with physicians our prime example. Examining local income inequality across U.S. regions, the data suggest that such spillovers exist for physicians, dentists, and real estate agents. Estimated spillovers for other occupations are consistent with the predictions of our theory.
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Who Values Human Capitalists' Human Capital? Healthcare Spending and Physician Earnings
July 2020
Working Paper Number:
CES-20-23
Is government guiding the invisible hand at the top of the labor market? We study this question among physicians, the most common occupation among the top one percent of income earners, and whose billings comprise one-fifth of healthcare spending. We use a novel linkage of population-wide tax records with the administrative registry of all physicians in the U.S. to study the characteristics of these high earnings, and the influence of government payments in particular. We find a major role for government on the margin, with half of direct changes to government reimbursement rates flowing directly into physicians' incomes. These policies move physicians' relative and absolute incomes more than any reasonable changes to marginal tax rates. At the same time, the overall level of physician earnings can largely be explained by labor market fundamentals of long work and training hours. Competing occupations also pay well and provide a natural lower bound for physician earnings. We conclude that government plays a major role in determining the value of physicians' human capital, but it is unrealistic to use this power to reduce healthcare spending substantially.
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Urban-Biased Growth: A Macroeconomic Analysis
June 2024
Working Paper Number:
CES-24-33
After 1980, larger US cities experienced substantially faster wage growth than smaller ones. We show that this urban bias mainly reflected wage growth at large Business Services firms. These firms stand out through their high per-worker expenditure on information technology and disproportionate presence in big cities. We introduce a spatial model of investment-specific technical change that can rationalize these patterns. Using the model as an accounting framework, we find that the observed decline in the investment price of information technology capital explains most urban-biased growth by raising the profits of large Business Services firms in big cities.
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Earnings Inequality and Coordination Costs: Evidence from U.S. Law Firms
September 2009
Working Paper Number:
CES-09-24
Earnings inequality has increased substantially since the 1970s. Using evidence from confidential Census data on U.S. law offices on lawyers' organization and earnings, we study the extent to which the mechanism suggested by Lucas (1978) and Rosen (1982), a scale of operations effect linking spans of control and earnings inequality, is responsible for increases in inequality. We first show that earnings inequality among lawyers increased substantially between 1977 and 1992, and that the distribution of partner-associate ratios across offices changed in ways consistent with the hypothesis that coordination costs fell during this period. We then propose a 'hierarchical production function' in which output is the product of skill and time and estimate its parameters, applying insights from the equilibrium assignment literature. We find that coordination costs fell broadly and steadily during this period, so that hiring one's first associate leveraged a partner's skill by about 30% more in 1992 than 1977. We find also that changes in lawyers' hierarchical organization account for about 2/3 of the increase in earnings inequality among lawyers in the upper tail, but a much smaller share of the increase in inequality between lawyers in the upper tail and other lawyers. These findings indicate that new organizational efficiencies potentially explain increases in inequality, especially among individuals toward the top of the earnings distribution.
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The Return to Knowledge Hierarchies
January 2007
Working Paper Number:
CES-07-01
Hierarchies allow individuals to leverage their knowledge through others. time. This mechanism increases productivity and amplifies the impact of skill heterogeneity on earnings inequality. To quantify this effect, we analyze the earnings and organization of U.S. lawyers and use the equilibrium model of knowledge hierarchies in Garicano and Rossi-Hansberg (2006) to assess how much lawyers, productivity and the distribution of earnings across lawyers reflects lawyers. ability to organize problem-solving hierarchically. We analyze earnings, organizational, and assignment patterns and show that they are generally consistent with the main predictions of the model. We then use these data to estimate the model. Our estimates imply that hierarchical production leads to at least a 30% increase in production in this industry, relative to a situation where lawyers within the same office do not vertically specialize. We further find that it amplifies earnings inequality, increasing the ratio between the 95th and 50th percentiles from 3.7 to 4.8. We conclude that the impact of hierarchy on productivity and earnings distributions in this industry is substantial but not dramatic, reflecting the fact that the problems lawyers face are diverse and that the solutions tend to be customized.
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Market Power And Wage Inequality
September 2022
Working Paper Number:
CES-22-37
We propose a theory of how market power affects wage inequality. We ask how goods and labor market power jointly affect the level of wages, the Skill Premium, and wage inequality. We then use detailed microdata from the US Census between 1997 and 2016 to estimate the parameters of labor supply, technology and the market structure. We find that a less competitive market structure lowers the wage level, contributes 7% to the rise in the Skill Premium and accounts for half of the increase in between-establishment wage variance.
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Hierarchies, Specialization, and the Utilization of Knowledge: Theory and Evidence from the Legal Services Industry
May 2004
Working Paper Number:
CES-04-07
What role do hierarchies play with respect to the organization of production and what determines their structure? We develop an equilibrium model of hierarchical organization, then provide empirical evidence using confidential data on thousands of law offices from the 1992 Census of Services. The driving force in the model is increasing returns in the utilization of acquired knowledge. We show how the equilibrium assignment of individuals to hierarchical positions varies with the degree to which their human capital is field-specialized, then show how this equilibrium changes with the extent of the market. We find empirical evidence consistent with a central proposition of the model: the share of lawyers that work in hierarchies and the ratio of associates to partners increases as market size increases and lawyers field-specialize. Other results provide evidence against alternative interpretations that emphasize unobserved differences in the distribution of demand or 'firm size effects,' and lend additional support to the view that a role hierarchies play in legal services is to help exploit increasing returns associated with the utilization of human capital.
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Cheaper by the Dozen: Using Sibling Discounts at Catholic Schools to Estimate the Price Elasticity of Private School Attendance
October 2011
Working Paper Number:
CES-11-34
The effect of vouchers on sorting between private and public schools depends upon the price elasticity of demand for private schooling. Estimating this elasticity is empirically challenging because prices and quantities are jointly determined in the market for private schooling. We exploit a unique and previously undocumented source of variation in private school tuition to estimate this key parameter. A majority of Catholic elementary schools offer discounts to families that enroll more than one child in the school in a given year. Catholic school tuition costs therefore depend upon the interaction of the number and spacing of a family's children with the pricing policies of the local school. This within-neighborhood variation in tuition prices allows us to control for unobserved determinants of demand with a fine set of geographic fixed effects, while still identifying the price parameter. We use data from 3700 Catholic schools, matched to restricted Census data that identifies geography at the block level. We find that a standard deviation decrease in tuition prices increases the probability that a family will send its children to private school by one-half percentage point, which translates into an elasticity of Catholic school attendance with respect to tuition costs of -0.19. Our subgroup results suggest that a voucher program would disproportionately induce into private schools those who, along observable dimensions, are unlike those who currently attend private school.
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Entry, Exit, and the Determinants of Market Structure
September 2009
Working Paper Number:
CES-09-23
Market structure is determined by the entry and exit decisions of individual producers. These decisions are driven by expectations of future profits which, in turn, depend on the nature of competition within the market. In this paper we estimate a dynamic, structural model of entry and exit in an oligopolistic industry and use it to quantify the determinants of market structure and long-run firm values for two U.S. service industries, dentists and chiropractors. We find that entry costs faced by potential entrants, fixed costs faced by incumbent producers, and the toughness of short-run price competition are all important determinants of long run firm values and market structure. As the number of firms in the market increases, the value of continuing in the market and the value of entering the market both decline, the probability of exit rises, and the probability of entry declines. The magnitude of these effects differ substantially across markets due to differences in exogenous cost and demand factors and across the dentist and chiropractor industries. Simulations using the estimated model for the dentist industry show that pressure from both potential entrants and incumbent firms discipline long-run profits. We calculate that a seven percent reduction in the mean sunk entry cost would reduce a monopolist's long-run profits by the same amount as if the firm operated in a duopoly.
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Where to Build Affordable Housing?
Evaluating the Tradeoffs of Location
December 2023
Working Paper Number:
CES-23-62R
How does the location of affordable housing affect tenant welfare, the distribution of assistance, and broader societal objectives such as racial integration? Using administrative data on tenants of units funded by the Low-Income Housing Tax Credit (LIHTC), we first show that characteristics such as race and proxies for need vary widely across neighborhoods. Despite fixed eligibility requirements, LIHTC developments in more opportunity-rich neighborhoods house tenants who are higher income, more educated, and far less likely to be Black. To quantify the welfare implications, we build a residential choice model in which households choose from both market-rate and affordable housing options, where the latter must be rationed. While building affordable housing in higher-opportunity neighborhoods costs more, it also increases household welfare and reduces city-wide segregation. The gains in household welfare, however, accrue to more moderate-need, non-Black/Hispanic households at the expense of other households. This change in the distribution of assistance is primarily due to a 'crowding out' effect: households that only apply for assistance in higher-opportunity neighborhoods crowd out those willing to apply regardless of location. Finally, other policy levers'such as lowering the income limits used for means-testing'have only limited effects relative to the choice of location.
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Impacts of Central Business District Location: A Hedonic Analysis of Legal Service Establishments
July 2011
Working Paper Number:
CES-11-21
This analysis examines the business impacts on law firms of locating in Central Business Districts (CBDs) in major U.S. cities. Specifically, we measure the price premium that law firms pay to locate in CBDs. Using micro-level data from the 1992 and 2007 Census of Services, we find that after controlling for firm size, firm specialization characteristics, and MSA and county attributes, law firms within CBDs pay about 15 to 20 percent more in overhead compared to those firms outside CBDs ' a result consistent across time between 1992 and 2007. When including an important additional measure of firm quality, however, we find that this impact is reduced to about 7 to 9 percent, but still statistically significant. Additional results show that there is a significant correlation between firm quality and CBD location. We also find that firm size and firm specialization measures are important factors in the choice to locate within CBDs. We argue that these results indicate that CBD location for law firms may serve as networking, quality sorting, and branding mechanisms.
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