Tests of labor market rigidities and the Roy Model

Previous studies examining labor market rigidities using the Roy Model have not incorporated the demand side. In this paper, I show that when the demand side is included, selection models of labor market rigidities based on the Roy Model in general lead to the prediction of mean wage differentials across sectors. This result is not surprising since the allocation of workers between sectors is determined by the marginal worker, not the mean or median worker, and an inducement differential may be necessary for demand to equal supply in each sector of the labor market. Previous tests of labor market rigidities are tests of the joint null hypothesis that under competition wages would be equalized across sectors and that wages are in fact equalized across sectors. They may, therefore, attribute differences in wage structure to rigidities that are, in fact, the result of equalization of supply and demand within the inducement model developed. An example is presented from the paper of [Dickens, W., Lang K., 1985. A test of the dual labor market theory. American Economic Review, 75(4), 792–805] using the Panel Study of Income Dynamics.