Globalization and the market for high‐ability managers

• Author: Carl Davidson,Steven J. Matusz
• Date: 01 March 2014
• DOI: http://doi.org/10.1111/ijet.12030
• Published date: 01 March 2014

doi: 10.1111/ijet.12030

Globalization and the market for high-ability managers

Carl Davidson∗and Steven J. Matusz†

Weadd heterogeneous workers and search-generated unemployment to a Melitz-style economy.

Depending on their productivity, firms choose to search exclusively for one of two types of

skilled workers, or possibly undertake a broad search for either.Increased globalization changes

the cost–benefit calculus of different search strategies and therefore alters the range of firms

willing to implement the alternative search strategies.

Key wor ds sorting, heterogeneity, wage inequality

JEL classification F16

Accepted 31 October 2013

1 Introduction

Fixed production costs play a critical role in many models of intraindustry trade. The inclusion of

such costs at the firm level ensures that firms are finitely sized and limits the variety of products

brought to the market. Fixed costs of exporting are central to modeling the empirically relevant

outcome that only a fraction of firms within an industry are strong enough to overcome those

costs and actually export (Melitz 2003). In addition, for firms that wish to serve foreign markets or

fragment production across international borders, it is the interaction of productivity differences

across firms and differences in the fixed costs associated with different methods of production (e.g.,

exporting, foreign direct investment (FDI), vertical integration, outsourcing) that determine the

optimal production mode for each firm (e.g., see Helpman et al. 2004 for exporting versus FDI;

Antr`

as and Helman 2004 for vertical integration versus outsourcing).1

In most models with heterogeneous firms, it assumed that firms cover their fixed costs either by

purchasing some of the numeraire good or by employing a fixed amount of homogeneous labor.2

Yet, at the level of the firm, we typically think of fixed costs as involving marketing, research and

development, and management. For exporting firms, fixed costs also pertain to the need to research

foreign markets and establish distribution networks.3The types of activities that contribute to

fixed production costs are different than those that contribute to variable cost, and presumably the

types of inputs used in undertaking activities associated with fixed costs are different than those

associated with variable costs. In general, one would expect that most fixed costs, and particularly

∗Department of Economics, Michigan State University,East Lansing, USA.

†Department of Economics, Michigan State University,East Lansing, USA. Email: matusz@msu.edu

1Ethier (1986) investigates the more fundamental issue of when a firm would choose to internalize its international

transactions or conduct them via arm’s-length agreement. For our purposes, we takethis decision as g ivenand assume

that international licensing is not an option.

2Krugman (1979, 1980), Ethier (1986), and Melitz (2003) assume that all costs are generated by the employment of

homogeneous labor. Helpmane t al. (2010a,b) assume that fixedcosts are created by the need to use some amount of the

numeraire good. Helpman (1984) introduces a “generalpur pose”input that must be adapted to suit the firm’s purpose.

3See Roberts and Tybout(1997) for ev idence on the importance of these costs.

International Journal of Economic Theory 10 (2014) 107–124 © IAET 107

International Journal of Economic Theory

The market for high-ability managers Carl Davidson and Steven J. Matusz

those associated with international commerce, are likely to be much more skill-intensive than the

variable costs associated with the production process.4Thus, as trade costs fall and firms alter their

level of international engagement, we would expect to see changes in the mix of fixed and variable

costs that firms incur, and such changes should have implications for wages as the relative demands

for high-skilled and low-skilled labor shift.

In addition, once one recognizes that setup costs are skill-intensive,other issues arise. For exam-

ple, we would expect managerial skill to vary considerably across the workforce, with higher-quality

managers commanding higher salaries than their counterparts. It follows that setup costs are “fixed”

only in the sense that they do not respond to changes in output; firms can control the size of their

fixed costs byeither using hig h-cost,hig h-productivity managers or low-cost,low-productivity man-

agers. Tobe a bit more specific, imagine that we could divide the labor market into two sub-markets:

one for managers with heterogeneous abilities; and one for production workers. We might expect

globalization to influence the market for managerial labor to the extent that globalization causes

management to be more or less valuable for any given firm and to the extent that the number of

active firms changes. For example, Melitz (2003) showsthat increased globalization results in higher

profit for the highest-productivity firms, reduces profit for lower-productivity firms, and reducesthe

overall measure of active firms.5Intuitively, these changes make higher-ability managers more valu-

able to high-productivity firms, but too costly for low-productivity firms. In addition, the number

of managerial positions may shrink as the measure of firms declines.

In this paper, we providea model in which fixed costs are more skill-intensive than variable costs

and in which heterogeneous firms can economize on their fixed costs by altering the quality of the

managers they employ. We then use the model to examine how globalization affects inequality when

these novel factors are taken into account. In our model, each firm requires exactly one manager

before it can proceed with production. Using the framework commonly associated with Mortensen

(1982), Pissarides (1990), and Mortensen and Pissarides (1994), we assume that firms must search

for managers. Firms and managers both differ by productivity. We follow Melitz (2003) and model

firm productivity as a draw from a continuous distribution. In contrast, we assume only two possible

productivities for managers. Withtwo-sided heterogeneity in the managerial labor market, the search

strategy used by firms plays a key role in our analysis. We construct an equilibrium in which firms

can be partitioned into three segments based on their productivity, corresponding to threepotential

search strategies. In this equilibrium, the lowest-productivity firms will economize on management,

eschewing high-skilled managers and their commensurately high wages, choosing to search only for

low-skilled managers. In contrast, firms at the highest end of the productivity distribution will only

hire the best managers, despite the increased cost. Thus, these firms will search only for high-skilled

managers. Finally, firms in the middle of the distribution will be willing to hire either type and will

therefore hire the first manager they encounter regardless of skill. Given the costs associated with

trade, the different types of firms self-select into different levels of international engagement. This

model then gives us a framework in which we can examine how increasing globalization impacts the

shares of the three types of firms as well as the wages and employment prospects of the two types of

managers.

This is not the first paper to explore the link between globalization and inequality in a model

with two-sided heterogeneity in the labor market.6Twopapers are particularly noteworthy. The first

4Weuse the words “skill” and “ability” interchangeably throughout the remainder of this paper.

5Krugman (1979) was one of the first to show that increased globalization can be expected to result in fewer domestic

firms. Many models of monopolistic competition share this feature.

6Egger and Kreickemeier (2012) consider a fair wage economy where entrepreneursvar y by ability which directly affects

the marginal productivity of workers employed by their firm. In Sly (2012), workers differ by their relative managerial

108 International Journal of Economic Theory 10 (2014) 107–124 © IAET