Does Unmeasured Ability Explain Inter- Industry Wage Differences?

This paper provides empirical assessments of the two leading explanations of measured interindustry wage differentials: (1) true wage differentials exist across industries, and (2) the measured differentials simply reflect unmeasured differences in workers' productive abilities. First, we summarize the existing evidence on the unmeasured-ability explanation, which is based on firstdifferenced regressions using matched Current Population Survey (CPS) data. We argue that these existing approaches implicitly hypothesize that unmeasured productive ability is equally rewarded in all industries. Second, we construct a simple model in which unmeasured ability is not equally valued in all industries; instead, there is matching. This model illustrates two endogeneity problems inherent in the first-differenced regressions using CPS data: whether a worker changes jobs is endogenous, as is the industry of the new job the worker finds. Third, we propose two new empirical approaches designed to minimize these endogeneity problems. We implement these procedures on a sample that allows us to approximate the experiment of exogenous job loss: a sample of workers displaced by plant closings. We conclude from our findings using this sample that neither of the contending explanations fits the evidence without recourse to awkward modifications, but that a modified version of the trueindustry-effects explanation fits more easily than does any existing version of the unmeasuredability explanation. Robert Gibbons Department of Economics MIT Cambridge, MA 02139 Lawrence F. Katz Department of Economics Harvard University Cambridge, MA 02138