Labor market differentials and the expected gain from search

Several recent empirical studies have used the residuals from estimated earnings equations as explanatory variables in models of on-the-job search and quit behavior. It has often been argued that the coefficients on these “market differential” variables are biased downward because estimated residuals overstate the “true” quasi-rent or disincentive to search for alternative employment. This argument—that observed wages include implicit payments for workplace and person-specific characteristics not fully specified in earnings models— ignores an opposing bias associated with the value of being able to reject unattractive wage offers. As a consequence, there is no unambiguous a priori relationship between estimated wage residuals and the theoretical expected gain from search. Some evidence bearing on the relative magnitudes of the two biases is discussed.