Heterogeneous Passthrough from TFP to Wages

What is the impact of firms' productivity shocks on workers' labor earnings? To answer this question, we propose a novel approach to identify firms' productivity shocks that combines a nonparametric production function estimation method with a set of two-way fixed effect regressions to control for differences in labor quality across firms. We apply this method on matched employer-employee data that encompasses the entire population of workers and firms in Denmark between 1995 and 2010. Our dataset allows us to separately study workers that stay in the firm across consecutive periods from those that transition between firms, to control for workers' endogenous job mobility decisions, and to investigate how the passthrough from firms' shocks to wages varies across narrow population groups. We find an elasticity of workers' hourly wages to firms' productivity of 0.08. This implies that a positive shock to firms' productivity of one standard deviation generates an increase of $1,100 US dollars in annual wages for the average worker in Denmark. This result also implies labor supply elasticities of around 5.6. We also find that both persistent and transitory shocks to firms are passed on to wages and that there is marked asymmetry in passthrough between positive and negative productivity shocks. In fact, after controlling for workers' endogenous mobility decisions, the elasticity of hourly wages to a negative productivity shock is twice that of a positive productivity shock of the same magnitude. This suggests that workers are more exposed to negative than to positive shocks to firms' productivity. Furthermore, we find that the changes in wages due to variation in firm productivity are quite persistent and do not dissipate even five years after the shock. By looking at the heterogeneity of passthrough across firm and worker groups, we provide insights about the theoretical mechanisms that could explain the patterns of passthrough we observe in the data.