Wage inequality and directed technological change: Implications for income distribution

Large evidence confirms substantial wage differences between small and large firms. The paper contributes the extant literature by discussing two competing hypotheses behind the higher average wage observed in large firms. According to the first line of analysis the wage premium reflects substantial differences in the bargaining power of unionized workers in large and small firms. According to the second, the joint presence of higher unit wages and higher skills in large firms is the consequence of the endogenous capital-intensive direction of technological change. The paper articulates and tests the hypothesis that wage inequality is at the same time a cause and a consequence of the direction of technological change. The empirical evidence based on a large sample of Italian manufacturing firms during years 1996-2005 confirms that the factor intensity of the production process is endogenous to firm size: small firms with lower unit wages rely on more labour-intensive production processes while large firms with higher unit wages and lower user capital costs adopt more capital intensive ones. Results confirm that the size of firms and the average wage account for the larger capital intensity of the production processes and average wages are themselves determined by the capital intensity.