The purpose of the project is to construct and estimate an equilibrium model of wages, employment and growth. The approach is based on a dynamic model of firm innovation and evolution developed by Klette and Kortum (2002). In their model, aggregate growth is viewed as the result of research and development investments made by firms. The process is one of Schumpeterian .creative destruction. in which new products replace old ones as in the theories of Grossman and Helpman (1991) and Howitt and Aghion (1992). There are several reasons for interest in the approach. First, it is consistent with empirical evidence on research and development investment made and patents filed by firms as wells as the evolution of firm labor force size. Second, it provides a model of labor demand that can be used to match the essential characteristics of worker flows into an out of employing firms as well as the size distribution of firms. Finally, the model establishes a clear link between labor market policies, the evolution of productivity and economic growth and employment. The first task among those proposed is to complete a formulation of the model that can be estimated using matched employer-employee data. The estimation strategy exploits the stochastic structure of the model and the empirical fact that firms differ with respect to the productivity of the inputs that they employ. These differences allow one to estimate the cost of firm expansion as well as the production function relationship between the quantity and composition of workers in the labor force of a firm and its value of output. Although initially the PI's intend to use the Danish Pay and Performance data to estimate the structure of the model, they also hope to estimate it using Longitudinal Research (LRD) and Longitudinal Employer-Household Dynamics (LEHD) U.S. databases. Cross country comparisons are essential for the policy applications proposed. Given the structural parameter estimates, the objective is to explore the model.s quantitative implications for cyclical responses to aggregate shocks and for the welfare effects of labor market policy. Does the model explain the observed magnitudes of cyclical variation in investment, employment, wages, and worker and job flows and the dynamic relationships among them? What are the implied magnitudes of the effects of payroll taxes, unemployment benefits, hiring subsidies and employment protection on wages, employment and growth? The answer to these questions is of critical importance to society at large. For example, the research should provide new insight into why employment and productivity growth in many European countries has lagged that of the U.S. in recent decades. Broader Impact: The principal investigators will offer the opportunity for undergraduates to engage in the activities of the project. The principal way in which they will do so is as research assistants. In addition, they would like to develop a macro-labor economics course, suitable for upper class majors as well as graduate students in economics and policy analysis, based on the project.s modeling approach and results.
