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Organization and Inequality in a Knowledge Economy

Jun 2003
Working Paper
By  Luis Garicano, Esteban Rossi-Hansberg
How does information technology a affect wages and organizations? To address this question, we model an economy formed by a continuum of agents, with different cognitive skills, who may produce on their own or may join in organizations with other agents to better utilize their knowledge. Our model generates an assignment of workers to positions, a wage structure, and a universe of knowledge-based hierarchies with different allocations of tasks, spans of control, and number of layers. We show that commonly observed phenomena such as positive sorting by ability, an increasing relationship between rank and cognitive ability, an increasing and convex wage schedule, and a positive relation between wages and firm size are natural consequences of the organization of knowledge in the economy. We then use our model to study the impact of information technology on the labor market and on the structure of firms. We show that the evolution of wage inequality and firm size is consistent with decreases in the cost of accessing information in the '80s and early '90s and decreases in the cost of communicating information in the late '90s. Our theory is also consistent with the evidence on decentralization, flatter hierarchies, and larger spans of control.