Real Wages and the Business Cycle: Accounting for Worker and Firm Heterogeneity

Using a longitudinal matched employer-employee data set for Portugal over the 1986-2005 period, this study analyzes the heterogeneity in wages responses to aggregate labor market conditions for newly hired workers and existing workers. Accounting for both worker and firm
heterogeneity, the data supports the hypothesis that entry wages are much more procyclical than current wages.

A one-point increase in the unemployment rate decreases wages of newly hired male workers by around 2.8% and by just 1.4% for workers in continuing jobs. Since we estimate the fixed effects, we were able to show that unobserved heterogeneity plays a nontrivial role in the cyclicality of wages. In particular, worker fixed effects behave countercyclically whereas firm fixed effects of new hires and separatin workers exhibit a cyclical pattern. Finally, the results point to a one-for-one response of wages to changes in labor productivity for both newly hired workers and workers in ongoing job relationships.