Research Papers in Economics,
Stockholm University, Department of Economics

Abstract: This paper calculates the quantitative significance of the welfare effects of wage compression in Sweden. This is done in a dynamic general equilibrium model with overlapping generations where agents choose both schooling (human capital) and assets (physical capital). This paper shows that when labor markets are competitive even low levels of wage compression lead to large welfare losses, since wage compression creates costly unemployment among low-skilled workers. This welfare loss can be significantly reduced (but not eliminated) if firms and unions bargain over efficient labor contracts. In both cases, the effect of wage compression on the supply of skilled labor is rather small, since the disincentive effect of a lower, high-skilled wage is, to a large extent, offset by a lower opportunity cost of schooling due to higher unemployment.

Keywords: Choice of schooling; quantitative macroeconomics; unemployment; university premium; wage compression; welfare

JEL-codes: D58; E24; E25; J24; J31

46 pages, January 20, 2000

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