We’ve all heard that median wages are stagnating, but that’s not all that is happening. Wages are also becoming increasingly segregated by firm—meaning, high wage employees are increasingly working in high wage firms and low wage employees work in low wage firms, rather than in firms with a mix of both.
by analogy to adverse selection in insurance markets.
Once a technological or organizational innovation has made it easier to screen or observe productivity difference, inter-firm competition drives the “pooling” wage equilibrium to unravel in a way that’s very hard to reverse since the separating equilibrium is self-reinforcing.
The consequences of this are big.
If this theory is right, it means reducing wage segregation is a lot harder than it looks, and comes with extremely ambiguous welfare gains. If inequality were really only a matter of elites appropriating rents, then a few tweaks to marginal tax rates and a one-time income redistribution would have a chance at being stable. In contrast, the separating wage equilibrium theory means income redistribution is ... like trying to pour an even level of water across a convex surface that invariably draws the water to its edges.