Garicano, Luis and Hubbard, Thomas (2011) Earnings Inequality and Coordination Costs: Evidence from U.S. Law Firms.

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Abstract

Earnings inequality has increased substantially since the 1970s. How much does this reáect decreases in coordination costs caused by improvements in Information Technology that allow individuals to better exploit returns to skill? We provide evidence on this question using conÖdential Census data on U.S. law o¢ ces. We Örst show that earnings inequality among lawyers increased substantially between 1977 and 1992, and that the distribution of partner-associate ratios across o¢ ces changed in ways consistent with the hypothesis that coordination costs fell during this period. We then propose a ìhierarchical production functionîin which output is the product of skill and time and estimate its parameters, applying insights from the equilibrium assignment literature. We Önd that, as a result of information technology improvements, coordination costs fell broadly and steadily during this period, such that hiring oneís Örst associate leveraged a partnerís skill by about 30% more in 1992 than 1977. We Önd also that changes in lawyersíhierarchical organization account for about 2/3 of the increase in earnings inequality among lawyers in the upper tail, but a much smaller share of the increase in inequality between lawyers in the upper tail and other lawyers. These Öndings indicate that new organizational e¢ ciencies potentially explain increases in inequality between individuals with very high and median earnings more broadly.