Firms’ pay practices play a key role in shaping wages, wage inequality and the gender wage gap, but this has so far only been reflected to a limited extent in the policy debate. The evidence in this report shows that around one-third of overall wage inequality can be explained by gaps in pay between firms rather than differences in the level and returns to workers’ skills. Gaps in firm pay, in turn, reflect dispersion in productivity, but also disparities in wage-setting power between them. To tackle rising wage inequality, worker-centred policies (e.g. education, adult learning) need to be complemented with firm-oriented policies. This involves notably: (1) policies that promote the productivity catch-up of lagging firms, which would not only raise aggregate productivity and wages but also reduce wage inequality; (2) policies that reduce wage gaps at given productivity gaps without limiting efficiency-enhancing reallocation, especially the promotion of worker mobility; and (3) policies that reduce the wage-setting power of firms with dominant positions in local labour markets, which would raise wages and reduce wage inequality without adverse effects on employment and output.

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