The authors document a large decline in earnings inequality in Brazil between 1996 and 2012, with the variance of log earnings falling by 26 log points. Using administrative linked employer employee data, we fit high-dimensional worker and firm fixed effects models within overlapping subperiods to identify the sources of this decline. Compression in firm effects accounts for 45 percent of the total decline and compression in worker effects accounts for 24 percent, with a fall in their covariance and the residual explaining the remainder.
Half of the decrease in firm pay differences and a fifth of the decline in heterogeneity between workers are explained by observable characteristics. While firm and worker characteristics became more dispersed over the period, a more than commensurate decline in returns to these variables lead to an overall decrease in earnings inequality.
The authors conclude that changes in pay policies, rather than changes in firm and worker fundamentals, played a significant role in Brazil’s inequality decline.
This research was funded under the Private Enterprise Development in Low-Income Countries (PEDL) Programme
Alvarez, J., Engbom, N., Moser, C. Firms and the Decline of Earnings Inequality in Brazil. (2015) 49 pp