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4
I
DEWEY
L..
Technology
Department of Economics
Working Paper Series
Massachusetts
Institute of
CROSS COUNTRY INEQUALITY TRENDS
Daron Acemogiu
Working Paper 02-1
February 2002
Room
E52-251
50 Memorial Drive
Cambridge,
MA 02142
This paper can be downloaded without charge from the
Social Science Research Network Paper Collection at
http://papers.ssm.com/abstract= xxxxx
*
4
Massachusetts Institute of Technology
Department of Economics
Working Paper Series
CROSS COUNTRY INEQUALITY TRENDS
Daron Acemoglu
Working Paper 02-1
February 2002
Room
E52-251
50 Memorial Drive
Cambridge,
MA 021 42
This paper can be downloaded without charge from the
Social Science Research Network
Paper Collection
http://papers.ssm.com/abstract^ xxxxx
at
Cross- Country Inequality Trends'
Daron Acemoglu,
February
7,
MIT
2002
Abstract
The economics
increase in
profession has
wage inequahty
in
made
but currently lacks a consensus on
much
less, in
(continental)
most popular explanations
skills
considerable progress in understanding the
UK
over the past several decades,
why inequahty
did not increase, or increased
the U.S. and the
Europe over the same time period.
for these difTerential trends:
increased faster in Europe, and that European labor market institutions pre-
vented inequality from increasing.
way towards accounting
I
argue that these two explanations go some
for the differential cross-country inequality trends,
do not provide an entirely satisfactory explanation. In addition,
relative
demand
this reasoning,
ing
review the two
I
that relative supply of
I
it
but
appears that
Motivated by
for skills increased differentially across countries.
develop a simple theory where labor market institutions creat-
wage compression
in
Europe
also encourage
more investment
in technologies
increasing the productivity of less-skilled workers, thus implying less skill-biased
technical change in
Keywords:
Europe than
in the U.S.
Relative Supply of Skills, Returns to Education, Skill-Biased
Technical Change, Technology Adoption,
JEL
*I
Classification
Numbers:
,130.
Wage Compression, Wage
Inequality.
J31.
thank Larry Katz and Timothy Smeeding, and seminar participants at Cornell and MIT for
Alexis Leon for outstanding research assistance, and the NSF and the Russell Sage
comments and
foundation for financial support.
.
Introduction
1
While over the 1980s wage inequaUty and
the U.S. and the
UK,
Eirropean economies
there
(see, for
was
less of
an
education increased sharply in
retiu'ns to
increase, or even
no change,
in continental
example, Freeman and Katz, 1995, Nickell and
Bell, 1996,
Blanchflower, Loveman, and Katz, 1995).
Table
and the
for a
1
illustrates these trends
log differences of the 90th
number
of countries
by showing an estimate of the education premium
and the 10th percentiles of the wage distribution
from the Lirxembourg Income Studies dataset (and
The
U.S. from the CPS, see Section 4 and the Appendix for data details).
replicates the estimates of the 90-10 differential for a
2 of the survey
by Freeman and Katz (1995)
U.S. inequality and
skill
premia were higher
and from there
countries,
with the exception of
for
comparison.
at the
table also
of countries from Table
The nimrbers show
end of the 1970s than
in
that
most other
on, they increased faster than in these other cases (perhaps
Israel)
These cross-country trends are well known. There
sus that U.S. wage inequality rose because the relative
than the
number
for the
relative supply (e.g.,
skill
also a fairly
demand
widespread consen-
for skills increased faster
Katz and Murphy, 1992, Berman, Bound and
1994, Katz and Autor, 2000, Acemoglu, 2002). So
developments increased
is
premia
in
much
why
haven't the
of continental
same
Griliches,
technological
Europe?
There are three broad types of answers:
1.
The
2.
European wage-setting
3.
For exogenous or endogenous reasons, technical change has been
in
The
to
them
relative supply of skiUs increased faster in Europe.
institutions prevented
wage inequality from
increasing.
less skill biased
Europe.
first
two explanations have been the most popular among economists, and
as the "traditional explanations"
.
Both of these explanations
fit
I
refer
nicely into the
relative-supply-demand framework, which has been a very useful tool in understanding
^
the U.S. wage inequality patterns.
Europe
equality in
shoiild
They both
employment
than
in the U.S. Is this
I
1
also
shows that during the 1980s the
of skilled .workers increased faster in a
for the stabihty of the
more rapid increase
number
European countries
of
employment
in skilled
account
sufficient to
European wage structure?
suggests that these explanations account for a significant component of
the differential inequality trends (in fact, for substantially
originally conjectured!). Nevertheless,
did not increase as
UK. More
relative
much
specifically,
demand
I
in
more than the author had
also appears that the relative
it
many European economies
as
it
demand
fmd that the relative-supply-demand framework, with the same
does a reasonable job of explaining some of the
shifts across countries,
number
Nevertheless, there are a
some degree
also to
this approach.
I
for skills
did in the U.S. and the
and Norway.
differences in the cross-country inequality trends, for example, for Finland
by
rel-
use a version of the relative-supply-demand framework to investigate this question.
The evidence
and
in-
have been associated with a relatively faster increase in the
employiBent of more skilled workers. Table
ative
suggest that the lack of increase in
of cases, in particular, Belgium,
where
Denmark, and Sweden,
premia increased much
less
than predicted
therefore conclude that the traditional explanations
do not seem to
Israel,
skill
provide an entirely satisfactory explanation for the differential inequahty trends across
countries. Instead,
not
shift in
appears that the U.S. and European relative
it
the same
way over the
it
curves did
past 20 years.
Given data quality and compatibility
caution. Nevertheless,
demand
suggests that
issues, tliis
evidence has to be interpreted with
we should be
tliinldng of explanations featuring
differences in technical change or technology adoption across these coimtries.
last part of the paper,
skills
may
I
propose a possible explanation
not have increased as
institutional
much
in
Europe as
for
in the U.S.
wage compression in Europe makes firms more
'Berman, Bound and Machin (1998) look
relative
The
willing to
demand
basic idea
is
shifts
all
of the
adopt technologies
OECD countries
and
in their sample.
have occurred at the same rate or with the same
change from industry
intensity across countries. In fact, to infer the overall rate of skill-biased technical
data would require a variety of strong assumptions.
for
that
at patterns of skill-upgrading in various industries
conclude that there has been skill-biased technical change in
However, their results do not imply that these
why
In the
complementary
making
to unskilled workers,
The paper proceeds
as follows. In the next section,
suggested above. In Section
whether cross-comrtry
3, I
4,
ineciuality trends
use data from the
I
investigation.
I
find that
Section
5, I
demand
demand
in relative
for skills across coimtries.
In
Luxembourg Income Studies and rmdertake such an
although the differential behavior of relative supphes between
much
of the differences, there
for skills did not increase as
make a preliminary attempt
demands change
review the three explanations
can be explained by the relative-supply-demand
the U.S. and continental Europe explains
that the relative
I
less skill bitised there.
develop a simple framework to quantitatively investigate
framework assuming similar changes
Section
change
teclinical
much
is
also evidence
in continental
at developing a simple theory
Europe. In
where
relative
differentially across com^itries. Section 6 concludes.
Review of the Arguments
2
Traditional Explanations of Differential Inequality Trends
2.1
The
traditional approaches explain the differential cross-country inequality trends by
differences in the behavior of relative supplies.
more rapid increase
The
first
in the relative supply of skills in
increase in inequality there.
The second
explanation claims that the
Europe accoimts
for the lack of
explanation, on the other hand, emphasizes
the role of European wage-setting institutions.
According to
this explanation,
it
is
not the differential growth of skilled workers in the population, but the differential
behavior of skilled employment that
across countries.
their
demand
More
is
responsible for differences
specifically, firms
for unskilled workers,
m
inequahty trends
respond to wage compression by reducing
and the employment of
that of unskilled workers) increases in Europe
compared
skilled workers (relative to
to the U.S.
As a
result, the
market equihbriates with a lower employment of imskilled workers compensating
their relatively liigher
Figure
1
wages
for
in Europe.
illustrates the first
explanation using a standard relative-supply-demand
diagram, with relative supply on the horizontal axis and the relative wage of skilled
workers,
a;,
on the vertical a^s.
For simplicity,
I
drew the
relative supply of skills
The diagram shows
as vertical.
supply of
skills, will
economy
of this
relative
demand
lead to higher
wage
for skills
grew
faster
u;P'-^
to a;US-Post_
first
level,
is
we can think
that because of
less skill-abunclant countries, the
is
for skills, the skill
also affected
skills also increases.
premium
rises
Then the "European" equilibrium
exliibit greater inequality
no change
by the same relative demand
This captmes the essence of the
in the skill
than before. In
premium
will
be at a point
Figure
fact,
1
like
E
wloich
depicts the case in
may
wMch
second one above
this story,
(e.g.,
Krugman,
—
minimum wages
for
1994,
OECD,
1994, Blau and Kalm, 1996).
is
the
To captm-e
example, because of union bargaining, unemployment benefits, or
that keep the earnings of low-skill workers in line with those of high-
workers. This can be represented as an institutional wage-setting line different from
the relative supply curve as
institutional wage-setting
drawn
unemployment. Now, even
in
premium might not
skill
in
Figure
relative
as the
of the story, there
^See,
among
I
drew the
increase; instead there will
this
relative supply curve, causing
the absence of an increase in the relative supply of
gap between the
demand and
(To make the story stark,
and consquently ojf the
In the figure, relative miemployiBent caused
shown
2.
hne as horizontal). The equilibrium now has to be along
institutional wage-setting line,
is
there
imagine that wage-setting institutions in Europe prevent wage inequaUty
from increasing
the
not
in Erurope.^
Probably the more popular explanation among economists and commentators
skill
from
explanation, where the supply of skills increases faster in continental Europe than
in the U.S.
is
demand
imagine that continental Europe
but the relative supply of
At a simple
a given
than the relative supply during the recent decades.
result of the increase in the relative
shifts,
for skills, for
where the consensus
change or increased trade with
As a
Now
inequality.
as corresponding to the U.S.,
skill-biased technical
demand
that an increase in the
skills,
be equilibrium unemployment.
by the increase
relative supply of skills
in the
demand
for skills
and the intersection between
institutional wage-setting hne. Notice that in the simplest version
is full
others, Katz,
employment of
skilled workers,
Loveman and Blanchflower
and Card and Lemieux (2001).
(1995),
and the indicated gap simply
Murphy, Riddell and Romer (1998)
unemployment.
reflects unskilled
relative to the U.S.
is
The
unemployment increased
fact that
demand
ciu-ves,
and
This relative- supply-demand framework
is
demand
an empirical investigation of whether these two approaches can provide
premia
skill
in continental
in
in Section 4,
I
3, I
present
we can
employment
of
develop a framework for undertaking such an investigation,
some empirical
Changes
Differential
2.2
An
If
workers are large enough to accovmt for the differential behavior of wage inequality
Europe. In Section
and
Europe.
the elasticity of substitution between skilled and unskilled workers,
investigate whether the observed differences in the growth of relative
skilled
curves.
not only a parsimonious specification, but
a satisfactory explanation for the behavior of
we know
Firms are along their
different supply behavior or institutional characteristics of
the European economies pick different points along the relative
also enables
Europe
often interpreted as evidence in favor of this explanation.-^
Notice that both of these explanations are "supply-side".
relative
in
results using
tliis
in the Relative
framework.
Demand
for Skills
alternative to the traditional explanations involves differential changes in the relative
demand
for skills across countries.
These
differential
changes could
reflect four distinct
forces:'*
1.
Different countries could develop their
own
technologies, with different degrees of
unemployment
Europe increased for all
and Bell (1994), Card,
Kramartz and Lemieux (1996) and Krueger and Pischke (1998). Nevertheless, some of the increase in
unemployment among the high-education workers in Europe may reflect the effect of wage compression
within education groups on job creation (e.g., if firms are forced to pay the same wages to low-skill
•'But in contrast to the prediction of this simple story,
groups, not simply for the low-education workers.
college graduates as the high-skill college graduates, they
increasing
''Yet
unemployment among
another alternative
function off their "relative
is
in
See, for example, Nickell
may
stop hiring the low-skill college graduates,
college graduates).
to introduce labor
demand
market imperfections that would also force firms to
curves" (the model of Section 5 features labor market imperfections,
still along their relative demand curves). An example would be efficient-bargaining between
and unions. Nevertheless, even if firms are off their relative demand curves, they will be located
along some equilibrium locus, and in this case we have to explain why this equilibrium locus is shifting
differentially. I am not aware of any analysis of cross-country inequality trends using a model where
firms are off their relative demand curves. Here I will develop an explanation that keeps firms along their
relative demand curves, but suggest why the relative demand curves may have changed differentially
but firms are
firms
across countries.
skill bias.
Some
2.
countries could be lagging behind the world technology frontier, and
may
not have adopted the most recent skill-biased teclmologies.
Wliile all countries face the
3.
skill-biased technologies
same technology
from
frontier,
some may have adopted more
this frontier.
Different countries have experienced different degrees of trade opening, affecting
4.
the
demand
for skills differentially.
Although the fourth explanation
the simplest, the current consensus
is
that in-
creased international trade played a limited role in the increase in the relative
demand
is
by Katz and Autor, 2000, and Acemoglu,
for skills of the recent decades (see the surveys
2002).
Therefore,
relative
demand
own
I
for skills.
technologies. In
conditions
make
this context, I
focus on the technological reasons for differential changes in the
it
Plausibly,
many advanced economies
Acemoglu (1999b),
I
develop some of their
analyzed a model where differences in local
profitable for countries to develop
showed that greater trade with
some
skill-scarce
of their ov,ti teclmologies. In
LDCs may
technical change in the U.S., while inducing the development of
technologies in Europe. Nevertheless,
it
gests that the
most
likely
differently in continental
why
Europe
not differential development of
the relative
skiU- replacing
OECD
set of technologies.
reason for
is
more
appears plausible that most
have access, and even relatively rapid access, to the same
cause skiU-biased
demand
for skills
may
new
economies
This sug-
ha\-e beha\-ed
teclmologies or
slow technology diffusion, but different incentives to adopt available technologies.
In the last section of the paper,
I
make a preliminary attempt
theory of differential adoption of available teclmologies.^ Here
main
idea, leaving the details to that section.
^An
briefly
summarize the
basic idea of the theory
I
propose
is developed by Beaudry and
more harmful to unskilled workers.
capital, and hurts unskilled workers.
alternative theory of differential cross-country inequality trends
Green (2000). They construct a model
The
The
I
to develop such a
in
which capital scarcity
introduction of a new technology increases the
In Europe, capital
is
relatively
workers do not decline as much.
more abundant than
demand
for
is
in the U.S., so the relative earnings of unskilled
is
to link the incentives to adopt
wage
structure, wliich
in part
wage compression
institutional
complementary
technologies to the degree of compression in the
determined by labor market institutions. In particular,
in Eirrope
makes
firms
more wilhng
to adopt teclmologies
to unskilled workers, inducing less skill-biased technical
change
there.
based on three premises:
This theory
is
There
is
1.
is
new
some degree
of rent-sharing
between firms and workers,
example,
for
because of bargaining over quasi-rents.
2.
The
3.
A
skill
bias of technologies
variety of labor
is
determined by firms' teclmology choices.
market institutions tend to increase the wages of low-skill workers
wages of comparable workers
in Europe, especially relative to the
All three premises are plausible.
firms' profitabihty or investments
The
both
in the U.S.
finding of high correlation between wages
in
union and non-union sectors
(e.g.,
and
Katz and
Summers, 1989, Groshen, 1991, Blanchflower, Oswald, and Sanfey, 1997) support the
view that there
is
is
some amount of rent-sharing. That teclmology adoption
close to the heart of
and
many
especially, 1999a, 2000), I
economists, and in previous work
wage compression
in
minimum
demand
for skills
it
it
can help
in the U.S.
wages, unions and social insurance programs create
Europe and increase the pay of
workers
low-skill
OECD,
is
widely shared
1994, Blau
and
that firms in Europe
may
(e.g.,
1996).
The new
find
how
and wage inequality
by most economists, and supported by existing evidence
Kahn,
endogenous
Acemoglu, 1998,
developed this theme in detail and showed
us understand the behavior of the
Finally, the view that
(e.g.,
is
more
implication of combining these three premises
profitable to adopt
American counterparts. This
is
new
is
technologies with unskilled workers than their
because with wage compression, firms are forced to pay
higher wages to unskilled workers than they would otherwise do (that
is,
greater than the
"bargained" wage). This creates an additional incentive for these firms to increase the
productivity of unskilled workers: they are already paying high wages, and additional
investments will not necessarily translate into higher wages. Put differently, the labor
market institutions that push the wages of these workers up make
residual claimant of the increase in productivity
their employers the
due to technology adoption, encouraging
the adoption of technologies complementary to unskilled workers in Europe.^
A
simple numerical example illustrates
worker's productivity
ogy
adopted.
is
tliis
also that
solely
adoption, the firm's profits are equal to 1/2 x 10
6
=
4.
The
by the
=
5,
to 10
—9=
1,
since
trast, its profits
it
above
18.
adopt the new technology
minimum wage
will
firm's profits without technology
legislation
be paid 9
now change
has to pay 9 to the worker because of the minimrun wage. In con-
with technology adoption are
laws, the firm
without technology
This implies that the worker
9.
The
adopt the new technology'. The reason
wage
technol-
while with technology adoption,
firm, therefore, prefers not to
requires the worker to be paid at least
is
when the new
Now
firm).
because of the subsequent rent-sharing. Next suppose that a
unless his productivity
Suppose that a
wages are equal to half of the worker's productivity,
and technology adoption costs 6 (incurred
—
clearly.
10 without technology adoption, and 20
is
Assume
they are 1/2 x 20
more
point
still 4.
for this
Therefore, the
change
is clear:
finxi
now
prefers to
because of the iTiinimum
was already forced to pay high wages to the worker, even when
marginal product was low, so
it
became the
effective residual
Iris
claimant of the increase in
productivity due to technology adoption.
may be
This reasoning imphes that there
greater incentives to invest in technologies
complementing workers whose wages are being pushed up by labor market
institutions.
Since European labor market institutions increase the pay of low-skill workers, teclinol-
ogy may be endogenously
An
less
skiU biased in Europe than in the U.S.
additional implicationn of this
make job
is
that institutional wage compression wall
creation less profitable in Eiirope, thus as in the second explanation above,
we expect unemployment
this story, the rise in
tionately
model
in
Europe
imemployment can be
on the rmskiUed, wliich
^This reasoning
is
to increase relative to the U.S. Interestingly, in
is
across the board rather than
fall
dispropor-
consistent with the evidence (see the references in
similar to the intuition for
why
firms find
it
profitable to invest in the training of
market imperfections in Acemoglu and Pischke (1999). It also
relies on the notion that firms obtain some "rents" from the employment relationship. In the absence
of such rents, firms would simply lay off workers when their wages are pushed up.
their employees in the presence of labor
footnote
3).
Therefore, the overall macro predictions of
county trends. However, as yet there
is
approach are consistent with cross-
tliis
no detailed evidence supporting
an empirical investigation of these ideas may be an interesting area
now
and
for futm^e research.
Shifts
develop the relative-supply-demand framework in more detail for a quantitative
Consider the following simple model
evaluation of the traditional explanations.
e.g.,
theory,
The Relative-Supply-Demand Prame^vork
3.1
I
Demand
Cross-Country Relative
3
tliis
(see,
Wekii, 1970, Katz and Mvnphv, 1992, or Acemoglu, 2002): there are two types
of workers, unskilled (low-education) workers
and
skilled (liigh-education) workers.
denote the employment of unskilled and skilled workers in country j at time
and H^
These employment
{t).
levels
because of differences in the education
may
The aggregate production
function for
by L^
{t)
vary across countries and over time both
levels of the population,
presence of labor market distortions, there
t
I
may be
and
also because, in the
imemploynient.
economy
j takes the constant elasticity of
substitution (CES) form
Y^{t)
where p
for
<
1,
and
A^, [t)
=
[{Ai{t)u{t)r + {Ai{t)w{t)rf',
and A^
{t)
are factor-augmenting technology terms, which are,
now, allowed to vary across countries. The
and unskilled workers
MPl [t) =
elasticity of substitution
in this production function is
The marginal product
(1)
cr
=
1/ (1
—
between
skilled
p).
of the two factors can be written as
{Al {t)Y [{Af {t)Y
+
{Ai {t)Y
[W
^'~'^"
{t)
IV
[t)y]
,
(2)
and
MPh = {K (0)'
[{^i {t)Y {H^
Suppose that wages are related
and
ufj^{t)
= pMPl
{t).
The
it)
lu
{t))-"
+
K
(i))
linearly to marginal product:
case where
/?
=
1
w-'^ (t)
= PMPj^
{t)
corresponds to workers being paid their
full
marginal product, with no rent sharing. Irrespective of the value of
wiit)
That
this specification firms will
is, 'in
Throughout the paper,
as returns to schooling)
I
will
be along their relative demand curves.
think of o'-'
[i]
both as a measure of skill premium (such
and as a measure of inequality. This
earn higher wages commensurate with their
will
skills as reflected
by
uj^ (t)
(see
practice, of course, there are
Juhn,
many
is
motivated by a reasoning
Murphy and
skills
other factors, in addition
Alternatively, as long as firms are along their relative
will
Equation
be more
"skilled",
and the market price of
Acemoglu, 2002). In
to,
or instead
of.
the
skill
identical workers.
demand
curve, the skill pre-
be
(3)
can be rewritten in a more convenient form by taking
cr
This equation shows that the
workers,
will
Pierce, 1993,
premium, determining wage dispersion among observationally
mium
we have
MPiity
whereby even among observationally equivalent workers some
and they
/3,
H^
{t)
/
U
{t),
skill
\A',{t)J
premium
is
logs,
\V{t)j
a
decreasing in the relative supply of skilled
except in the special case where a —> oo (where skilled and
unskilled workers are perfect substitutes).
Another important point to note from
this equation is that as long as
>
1, i.e.,
as
/A]
(t)
premiimi and wage
in-
cr
long as skilled and unskilled workers are gross substitutes, an increase in Aj^
corresponds to skill-biased technical change and raises the
equahty. Interestingly,
skill- biased
when
cr
<
1, it is
a decline in
technical change (see Acemoglu, 2002).
A-'^^
{t)
skill
/Af
But the
(i)
(t)
that corresponds to
case with
cr
<
1
is
not of
great empirical relevance in the context of skilled and imskilled workers, since ahnost
existing estimates suggest that
cr
>
1
(e.g.,
Freeman, 1986).
10
all
.
.
Let us start with a relatively weak form of the
common
technology assumption. In
particular, suppose that
Ai
it)
=
viO' (0
Ah (0 and Aj
=
{t)
This assuiBption can be interpreted as follows. There
by Ah
tries
(t)
and Ai
(f),
wliich potentially
may differ in their ability
by the term
6-'
{t).
advantages
ti\'e
assumed to be time
J
c-
=
a
[t]
= ^^
or less skill-biased over time.
sectors. In addition, comitries
(4),
and
rfl
tliis is
captured
time varying,
different
it is
compara-
(though these are
/?/
In
{A^
{t)
=
/Ai
c'+\na{t) - 1
[t)) is
In
(f^)
(6)
,
the measure of skill-biased technical change, and
^izln^
^vi/vi-
A In a [t),
where j
=
for the
change
using an estimate for the elasticity of substitution, a
Alna(0 =
refers to the U.S.
imskilled workers, a,
consensus that
e.g..
is
may have
the ternis
Then, using U.S. data we can construct an estimate
by
and
Comi-
we obtain
Ino;^ (i)
In
a world technology represented
world technology
b\-
(5)
invariant).
Substituting (5) into
where
ability to use
two sectors as captured
iu the
is
'
(i)
to use the world technology efficiently,
Although the
symmetric between the two
becomes more
A^
r^^O^ [t]
it is
ou.
Although the
to pin
is difficult
greater than
1,
,
{t),
denoted
as:
n
.
elasticity of substitution
down
a
i..V^"(0
+ -^1"
Aln.^^'(0
in In
precisely, there is
perhaps aroimd
1.4,
a
between
skilled
and
fairly well-established
but possibly as large as 2
(see,
Freeman, 1986, Katz and Mirrphy, 1992, Angrist, 1995, Card and Lemieux, 2001).
Hence, in the empirical exercise
Now
defme
I
will use
cr
=
1.4
and
Afe as the /c-period difference operator,
AfcX
Then, predicted changes
in the skill
=
X
{t)
—X
premiirm
11
{t
for
—
cr
=
2 as two reference values.
i.e.,
k)
country j between between
t
—
k and
t
are given by:^
AfclncI;^ {t)
The
new
implicit
assumption
=
Afclna(i)
- ^A^ln
(f^)
in this exercise is that there is
teclinologies across countries. Instead,
it is
(7)
no delay
some
quite possible that
adoption of
in the
new
of the
skill-
biased technologies developed or adopted in the U.S. are only introduced in continental
Europe with a
lag.
4
(i)
That
=
implying that there
instead of
is,
viO'
Ah
{t)
a delay of
is
-
{t
y
(5),
we would have
and AJ
k^)
(t)
=
77/^^ (t)
A
[t
-
k^)
(8)
,
periods for country j in the adoption of frontier
technologies.
Motivated by the possibility of such delays, as an alternative method
I
use U.S. data
from 1974 to 1997 to recover estimates of Alna(i), and calculate the average annual
growth rate of Ina(i), denoted by
predicted change in the
skill
g.
I
premimu
in
then construct an alternate estimate for the
comrtry j between dates
t
—
k and
as:
t
A,ln^^-(t)=^fc-^A,ln(|^^
In
tliis
exercise,
I
use 1974 as the starting point, since
earliest observation for
is
five
any other country from the LIS data, and
reasonable time lag for diffusion of technologies
as the final year, since this
my
it
(9)
is
among
five
OECD
the
the final year for wliich there
is
years prior to the
years appears as a
countries.
LIS data
for
I
use 1997
a comitry
in
sample.
Whether the relative-supply-demand framework provides a
for cross-coimtry inequality trends
skill
premium changes, the A^
actual changes, the
^Equivalently,
At
we can
can then be investigated by comparing the predicted
\\\Cj-'
(f)'s
from
A In x^
(t)
= A In a;^
fit
and the
Afclna)-' (i)'s
from
(9),
to the
write:
=
a
provides a good
(7)
Inu;^ (i)'s.
Alnc^(t)
where
satisfactory explanation
(t)
—
A In x° (t)
with j
Aln
=
to the data.
12
'
'
\V
^
(t)
as the U.S.,
and
investigate whether this equation
Can
4
Differences in Relative Supplies Explain In-
equality Differences?
Data
4.1
I
now undertake a
tive supplies
preliminary investigation of whether differences in the behavior rela-
can explain the differential inequality trends across countries. More
cally, I investigate
whether equations
country inequality trends,
for
I
(7)
and
use data from
(9)
specifi-
provide a good description of the cross-
Luxembourg Income Study
(LIS) dataset (see,
example, Gottschalk and Smeeding, 1997, for an im-estigation of cross-country
come
inequality using this dataset,
of differences in
ferent years,
I
wage
inequality).
and Gottschalk and Joyce, 1998,
Because LIS data
for
in-
an investigation
for different countries refer to dif-
combine these with the March Current Population Siurveys (GPS)
for the
corresponding years.
There are a number of difficulties
on years of schoohng or education
there
is
in using the
is
LIS
for this purpose. First,
missing for a nmnber of countries. In particular,
no consistent education information
for the
UK and Sweden,
lands, the education categories change over the sample period in a
difficult to
for
information
and
for the
way
Nether-
that makes
it
construct comparable relative supply numbers. Second, for some countries,
example, Belgium and Prance, incomes are reported after taxes. Third, because the
LIS sample
is
limited to household heads, relative supplies have to be constructed for
heads of households instead of the whole population.
information
skill
is
Finally,
because weeks worked
missing for some countries, annual earnings have to be used to construct
(coUege) premia. These difficulties notwithstanding, the LIS provides a convenient
data set
for
a preliminary look at whether differences in relative supplies could account
for the differential inequality trends.
The
skill
premia are obtained from a log-wage regression analysis using annual earn-
ings of full-time- fuU- year
male household heads aged of 18-64. The "college premium"
is
estimated as the coefficient on the diunmy for college education. Following other authors,
in the case
where there
(this is the case for the
is
no education information,
I
use information on occupation
UK and Sweden, see the Appendix).
13
The
regression also contains
other education dummies, a quartic in age (since experience cannot be constructed for
every country), and a race or immigrant
For the
1.5
CPS
calculations,
when
dummy when
apphcable (see the Appendix).
earnings are top coded, they are assigned the value of
times the tope code.^
The 90-10 wage
differential
is
simply the log difference between the earnings of the
household head at the 90th percentile and those of the household head at the 10th
percentile (again the sample
is
limited to
full- time- full- year
Relative supplies are constructed adapting the
(1998) to the data available here.
equivalents divided by the
number
In particular,
method
it
is
male heads of households).
of Autor,
Katz and Krueger
the ratio of niuuber of college-
of noncollege-equivalents. Here,
I
define college
and
noncollege equivalents as follows:
college equivalents=college graduates-|-0.5x workers with
some
college,
and
noncollege equivalents=high school dropouts and graduates-|-0. 5 x workers with
some
col-
lege.
When
(see the
college information
is
Appendix). Moreover,
not available, occupations are used for this calculation
for
the Netherlands and Germany, there
category for those with some college.^
is
no separate
Presumably, workers with some college are
al-
ready included either with those with secondary education or among those with college
education. Tliis
countries. For
may
create problems with the relative supply estimates from these two
aU these calculations,
I
use a sample of male heads of households rather
than the whole population, since the LIS only has information
To
for
heads of households.
the extent that there are differential trends over the years across different countries
in female labor force participation, this hmitation of the
LIS may create biases in the
analysis here.
^Because the sample is narrower than usual (in particular, it excludes women), is not weighted by
weeks worked, and includes age instead of experience controls, the college premium for the U.S. is
estimated to be lower than usual.
^For Germany, we only use data from 1989 and 1994. The survey also includes data for 19S1 and
1984, but the 1981 survey is the first LIS survey, and data quality is low and LIS advises against the
use of this survey. The 1984 survey has a very different classification of education, and implausibh' few
people outside the categories of high school and high school and less. .Although I report overall wage
inequality numbers from the survey in Table 1, I do not use it for calculating returns to schooling or
relative supplies.
14
Because there are a number of problems with the French data
are reported after taxes, there
is
is
no education variable
for the first
not possible to limit the sample to full-time- full year workers),
the analysis.
I
also exclude
(for
LiLxembourg since the sample
I
example, incomes
two surveys, and
it
exclude France from
size is small.
Empirical Results
4.2
Figures 3a-c and 4a-c show the results of the empirical exercise. Figures 3a-c depict the
estimates obtained from (7) for two values of the elasticity of substitution,
cr
=
2,
while Figures 4a-c show the estimates from
of the elasticity of substitution. In
all
A/elnu)-' (i), are translated into level
cases, the
of patterns are apparent
and which estimate of the
and Canada, the predicted
for the
UK,
the college
skill
change estimates, Aklnuj-'
premium
from the
and
and the
(t)
year estimate for
which method
and
First, for Australia
premia estimates are close to the actual estimates, while
premium
increases
more than
predicting too large an increase in the skill premia
is
first
figures, irrespective of
predicted. Therefore, there
evidence that the relative-supply-demand framework with
This conclusion
1.4
for that country.
elasticity of substitution are used.
skill
=
again for the same two values
estimates by choosing the
each country to be the same as the actual
A number
(9),
cr
consistent with the results of Katz,
common
among
is
no
technology trends
is
the Anglo-Saxon countries.
Loveman, and Blanchflower (1995),
Murphy, Riddell and Romer (1998) and Card and Lemieux (2001). The predicted skiU
premia estimates are also close to the actual estimates
for
Finland and Norway.
Second, for the Netherlands, the predicted
skill
premia decline, whereas the actual
premia remain approximately constant.
This
reflects substantial increase in the
skill
relative supplies of skills in this coimtry.
Given the shortcomings of the LIS data
for
the Netherlands noted above, increases in the relative supply of skills are likely to be
overstated,
and these
results
need to be interpreted with caution. Next,
Norway and Finland the predicted and actual
skill
premia move more or
for
Germany,
less in
tandem.
Hence, the relative-supply-demand framework with coimnon technology changes appears
to perform well for these countries,
relative
supply changes
may be
though
it
has to be borne in mind that
overstated in the LIS data.
15
German
Finally, for Belgiiun,
Denmark, and Sweden, the predicted
premia estimates
skill
increase substantially while actual skill premia are approximately constant or actually
declined.
For
the
Israel,
same
result is obtained using the first
method, but not the
second. Given the quality of the LIS data, these results have to be viewed as preUminary,
and more work using detailed microdata from these countries
is
necessary to reach
firmer conclusions. Nevertheless, the results suggest that for a significant fraction of the
continental European coimtries in the sample, the relative-supply-demand frajBework
with
common
technology trends does not provide an entirely satisfactory explanation
for the differential
skills
behavior of
skill
premia. Instead,
increased substantially less in Belgium,
it
appears that relative
Denmark and Sweden than
demand
for
in the U.S. or
other Anglo-Saxon comitries.
A
5
I
Model
now develop
of Differential Technology Responses
a simple theory which links the adoption of skill-biased technologies
to labor market institutions,
may have been
framework
I
and provides an explanation
less skilled-biased in
Europe than
on training investments
why
in the U.S. Tliis
developed in Acemoglu (1999a), and combines
of the literature
for
it
technical change
theory builds on a
with some of the insights
in the presence of labor
market
frictions (e.g.,
Acemoglu, 1997, Acemoglu and Pischke, 1998, 1999).
The
basic idea
to invest in
greater
skill
new
is
that in a labor market with
technologies
is
wage compression may
workers.
I
affected
wage bargaining, the
incenti\-es of finns
by the degree of wage compression. In
particular,
increase firms' incentives to raise the productivity of low-
then suggest that the greater institutional wage compression in Europe
may have encouraged
firms to adopt certain technologies with low-skiU workers that U.S.
firms did not adopt.
Throughout,
to
I
wiU keep the presentation at a heuristic
Acemoglu (1999a)
for
level.
The reader
is
referred
a fuUer discussion of a similar model (but without an analysis
of the impact of differences in wage-setting institutions
16
on technology
clioices).
The Environment
5.1
There
a continuum
is
of workers that are infinitely hved
1
value of income discounted at the rate
have
hu
<
human
capital
/i^,
wliile the
A
r.
of these workers are skilled,
fraction
remaining workers are unskilled with
human
in this
economy are created
imemployed workers, there
matters
will
skilled
that the function
for
V
there are
be M({7, V) new matches created.
and unskilled workers
will ha^•e
M exhibits constant returns to
simply by the tightness of the labor market, 6
worker
When
vacancies and
a vacancy
rate for an
Notice that what
is
q(6)
where g
unemployed worker,
is
=
the
same matching
probability
rates.
scale, so matcliing rates are
jj.
The
determined
a decreasing function. The probability of matching
in turn, is 6q[6),
which
is
assumed to be increasing
at the
7^
when they
post a vacancy at time
in d.
exogenous
Once they match
t.
with a worker, they decide what type of a job to create. In Acemoglu (1999a),
I
assume
s.
Firms incur a setup cost
more
I
probability of matching with a
assume that matches between firms and workers come to an end
also
U
the total nun:iber of unemployed workers (skilled plus unskilled), and as a
is
both
result,
Here
capital
Diamond
via costly search as in the models by
Mortensen (1982), and Pissarides (1990).
(1982),
the
and
hs-
Jobs
I
and maximize the net present
realistic
I
analyzed
(and involved) case where firms decide the type of job before matching.
focus on the case where this decision
the analysis. Specifically, at time
f,
is
made
after
matching
in order to simplify
a firm matched with a worker of
hmnan
capital
h
can either produce
Ath
units of the final good, without incurring any additional costs, or
additional investment of cost
kt
One
it
can undertake an
and produce
{I
where a >
(10)
+
a) Ath,
(11)
0.
possible interpretation of the choice between the two technologies
17
is
that firms
can either use
last period's
technology at no cost, or adopt the frontier teclinology by
incurring an additional cost every period.
Notice that the multipHcative nature of the production function in (11) makes
technology complementary to
new
skills.
Also in terms of the framework discussed in the previous section, the elasticity of
substitution between skilled and unskilled workers
unaffected by relative supphes. Tliis
is
and wage inequaUty
is infinity,
to simplify the discussion
and focus on
is
differential
technology responses of different economies.
Analysis
5.2
The discounted
net present value of a firm with technology adoption decision Xf e {0, 1}
and matched with a worker of
Jt (xt, h)
=
Ath +
Xt
{aAth -
skill
kt)
~
h G {hu,hs} can be written as
Wt
(xj,
h)
1
+
1
+
sVt+i
+
(1
-
s)
r
max Jt+i
{xt+i,h)
^t+i
(12)
where Wt
(xf,
h)
of the worker,
is
the wage as a fimction of the technology decision and the
and Vt+i
is
the value of a vacancy at time
t
+
I.
skill level
The wage may depend
on the teclinology decision because of bargaining over the quasi-rents created by search
frictions.
The term
sVt+i
is
added because with probability
and the firm becomes an imfiUed vacancy.
value conditional on no separation, and
I
Finally, the last
s,
there
term
have imposed that there
separations. This will be the case in steady state,
and
I will
is
will
is
a separation,
the continuation
be no voluntary
focus on the steady state
allocation for simphcity.^"
Next suppose that At and
kt
grow exogenously
at a constant rate, g,
At
=
{1
+ gYA
kt
=
{l
+ gfk.
i.e.,
(13)
'"Away from the steady state, workers may want to end the relationship with a firm that does not
adopt the new technology voluntarily, and I'm ignoring this case in writing equation (12). In any case,
such voluntary separations would never happen along the equilibrium path, since the technologj- adoption decisions are taken every period, so the firm would never choose not to adopt the new technology
when
it
knows that
this will result in a quit.
18
'
In addition, assume that wages are equal to a fraction
wt{xt,h)
=
The important assumption incorporated
l3[l
+
(3
of the worker's ex post product:
Xta)Ath.
in this expression
new
takes place after the firm sinks the cost of
(14)
that wage determination
is
teclmology. This
is
tice given the impossibility of wTiting binding
wage contracts, and
are negotiated throughout the duration of the
employment
technology-related decisions are
made
'
reasonable in practhat, wliile
wages
many
of the
relationship,
before or at the beginning of this relationship.
Using (14) and the fact that both productivity and costs are growing at the rate g as
specified
by
(13),
new technology
we can rewrite the steady-state value
(x
=
1)
and that of a job that never adopts the new technology
J{x,h)
where
8
=
~^^^^
is
of a job that always adopts the
=
6[[l-l3){l
(;r
=
+ xa)Ah-xk]
0):
(15)
the effective discount factor, taking into accomit time preference,
separation probabihty and productivity growth.
Notice that the firm only receives a fraction
cost of investment.
full
is
a standard
result,
As a
1
— /3
of the output, though
it
incurs the
This
result, firms will tend to underinvest in teclmology.
going back at least to Grout (1984), and also emphasized in the
context of search equihbrium by Acemoglu (1996).
It is
straightforward to see that, in steady state, firms will choose to adopt the
teclmology with a worker of
skill level
h
if
and only
if
J
(x
=
1,
h)
>
.7
(x
=
0, /i),
or
{l-l3)aAh>k.
The
skills,
and therefore more
if
(16)
fact that the left-hand side of this expression is increasing in
technologies are complementary to
new
h
reiterates that
likely to
new
be adopted with
skilled workers.
Next, consider the case:
{\-0)otAK>k.
(17)
'^More formally, I'm assuming that wages are determined by outside-option bargaining as in Rubenand Shaked and Sutton (1984) (see Acemoglu, 1996, for a justification in the search equi-
stein (1982)
librium context).
19
This condition ensures that firms are happy to adopt a new technology even with unClearly (17) immediately implies that (1
skilled workers.
—
(3)
aAhs >
k.
So the new
technology will be adopted with skilled workers as well. Then, wages will be given by
w^ = P
so the skill premirun (or the
{1
+
Ahu
a)
_ w^t _
~ w^
implemented both with
towards
t
in each period
hu
stable,
because
new
all
technologies are
and unskilled workers, so technical change
rate. In particular, given condition (18),
is
"neutral"
=
-it
(1
+
q{Ot)
)max{Jt
-(/))max{.7t(x
7j is the cost of
unskilled.
The
the value of a vacancy
as:^^
=
{x
—
l,/i„);
1,
hs)
Jt(x
;
=
Jt{x
=
0,
hs)}
+
0,/i„)}
(19)
-
(1
g(^t))
max{T4+i;0}
J
opening a vacancy. With probability q{9t), the vacancy matches
with a worker, and with probability
is
simply
hs
X
he
is
steady technical change, and wages are increasing at a
skilled
can be written
+
Here
(18)
.
straightforward to characterize the equilibrium tightness of the labor market
and the unemployment
Vt
Ath„
a)
skills.
It is also
at time
is
But wage inequality remains
constant rate.
= p {1 +
measure wage inequality)
^
In this equilibrimn, there
and wt
0, this
worker
is skilled,
and with probability
firm then decides whether to adopt the
captured by the "max" operators. With probability
1
—
new technology
q{9t), there
1
—
d,
or not as
no match, and
is
then the firm decides whether to keep the vacancy, obtaining the value Vt+i or shut
down.
Assume
and impose
that the cost of vacancy
free entry,
-y^
also grows at the rate g, that
which implies that
Vt
= K+i =
0.
is,
7j
=
Then, using
(15),
-
=
(1
-1-
g) 7,
we obtain
that in steady state:
V = ~j + q
{9''"') [6 ((1
-f3){l
+ a)A-
k)
(</>/i,
+
(1
0) K)]
0,
^^ Without loss of any
generality, I'm using the timing convention that a vacancy that gets
period can start production in this period.
20
(20)
filled this
.
6^"' is the steady-state tightness of the labor
where
denoting the fact that
and the whole
tliis
market, with the superscript "Pre"
refers to the case before the tecliriology shock.
This tightness
equilibriiun allocation are defined uniquely.
Next, the steady state unemployment rate for both skilled and mrskilled workers
^
The important
ment
will
rate,
Change
Now
>
i.e.,
and that
is
this
in
unemployment
From
Ar+t
shock,
we
=
rate
a decreasing function of
is
same unemploy-
^:
unemployment
is tighter.
Technology Regime
imagine that the economy
kx-^'^
''''
7Tkwy
that both skilled and unskilled workers have the
be lower when the labor market
5.3
k'j^
point
=
is:^''
this point
(1+5)'^t and
is liit
by an adverse shock
A grow
onwards, both k and
fcj+j
=
-
aArh, >
[l
+ gYk'j.. Assume
at time T, increasing
at at the
same
kj-
to
rate as before,
also that following this technology
have:
(1
P)
>
k'j-
[l
-
aArK.
(3)
Condition (22) implies that firms, fi-om this point onwards,
new technology with
wages at any time
t
is
now
will
continue to adopt the
with unskilled workers. That
skilled workers, but not
technology adoption condition (16)
(22)
satisfied for skilled
is,
the
workers only. As a
new
result,
>T are now
Wf
=
so after this technology shock,
l3Athu and
u'f
=
wage inequahty
wf
,
'^•
=
^
(3 {I
<'
a) Ath^.
increases to
.
=
+
.
+
hs
"'fc:-
unemployment rate equation follows by equating to the flow out of unemployment, Oq (6) u, to
the flow into unemployment, (1 — s) u. The fact that both types of workers have the same unemployment
rate is a consequence of the simplifying assumption that all search is undirected, and no matches
are turned down. It is straightforward, but cumbersome to generalize the model by adding some
heterogeneity, or by allowing firms to turn down workers as in Acemoglu 1999a)
'"Notice that I am taking the technology shock to be an increase in the cost of new investment. This
is consistent with the fact that all the countries in question experienced a TFP slowdown over this time
period. Nevertheless, many other economists view the 1980s as a period of more rapid technological
change (e.g., Greenwood and Yorukoglu, 1997, Hornstein and Krusell, 1996). See Gordon (1998),
Jorgensen and Stiroh (2000) and the discussion in Acemoglu (2002).
'''This
(
21
unemployment
In addition,
both types of workers increases. To see
now changes
the free-entry condition
V=-^ + q
for
(^'-'S-Po^t^)
[^
(^ ((1
_
^)
wliich incorporates the fact that
miskilled workers.
it
The
to
+
(1
now
^)
^_
;,) ;,^
+
_
(1
^) (j
change
is
in technology in the
_
^)
y^/^^^]
=
(23)
q,
new technology with
firms will not adopt the
steady-state labor market tightness
refers to the equilibrium after the
this note that
denoted by 9
~^°^^^
since
model economy supposed
to approximate the U.S.
Comparing
this expression to (20)
change, opening a vacancy
So
fallen).
^^^'P°''*
<
is,
increase.
9,
tlie
9^^'^,
is
now
shows that, as a consequence of the teclinology
less profitable (i.e.
the term in square Vjrackets has
tightness of the labor market, has to decline to satisfy (23)
This impHes, from equation
(21), that the
imemployment
—that
rate will
^'^
So at a very simple
model
level, this
illustrates
how a
technological shock might
increase wage inequality by changing the technology adoption decisions of firms. After
the change in technology, firms find
skilled workers,
premium
and as a
profitable to invest in
technologies only with
result, the relative productivity of skilled
in the
Technology Regime
Now, consider a different environment, meant
tal
new
workers and the
skill
increase.
Change
Hbrium
5.4
it
European labor market. In
this
is
a
"European" Equi-
to proxy at a very crude level the continen-
environment, there
compression, for example because there
for unskilled workers.
in the
is
institutionally
minimum wage
imposed wage
at a level that
is
binding
This contrast captures in a styUstic way the differences between
the American and continental European labor markets.
For example, Blau and
Kalm
(1996) provide evidence in favor of the hypothesis that labor market regulations compress
wage
'^This
is
differences at the
bottom
consistent with the fact that
of the distribution in Europe.
They show
that
unemployment both among low and high education workers
the U.S. increased during the 1980s (see Acemoglu, 1999a).
22
in
although wage differentials between the 90th and the 50th wage percentiles are similar
and 10th percentiles
across countries, the differential between the 50th
much
is
larger in
the U.S. than Europe. Union wage setting, which extends wage floors across firms, or
mimmum
relatively high
probably at the root of
wages, as well as more generous social insurance progr'ams, are
wage compression.
tliis
Denote the minimum wage in
minimum wage has
the
So
I
assume ^t
=
to
grow as
well
,5(1
is,
the
+
minimum wage
not adopt the
new
—otherwise,
u^;.
it
skilled worker. Since
would quickly become
Ahu >
q)
w> PAhu
and i3Ahs
binding for a firm that
is
it is
And
unskilled worker.
same configuration
minimmn wage
In the presence of the
Irires
it is
at all
=
>
t
=
0:
(24)
an miskiUed
w^orker
and does
never binding for a firm employmg a
minimum, the worker
is
the unregulated economy,
camiot apply, since
to:^''
+ Xta)Ath,w^}
(25)
.
mimmum
wage
is
below
simply paid the minimum. Since nothing has changed for
i.e.,
(1
But the technology decision
will
(14)
than the minimum. Hence, consider
the "eciuilibrium bargained wage" in the absence of the
minimum wage
at time
w.
wage equation
less
rmix{Pi\
skilled workers, the condition for the
the
irrelevant.
t
law, the
some workers would be paid
Wt{xt,h)
the
growing,
not binding for a firm that adopts the
a straightforward generalization of this wage equation
if
is
both productivity and minimum wages grow at the same constant
rate, (24) ensures the
So
Since the economy
most convenient to assume that
it is
technology. In contrast,
new technology with an
(24) implies that
by
^
+ gYw
(1
Also to illustrate the main point,
That
time
effect at
—
new technology
/3) (1 4-
a) Ahg
for unskilled
be binding
>
to
be adopted
is
the same as in
k.
workers has changed. In particular,
for a firm
now
employing an unskilled worker with the
old technology, so
J{x =
0,
K) =
6
{Ahu -w).
(26)
'^This wage rule follows from is straightforward application of the Rubinstein (1982) bargaining model
with outside options (see Shaked and Sutton, 1984).
23
,
In contrast,
worker
tlie
is still
when the
firm adopts the
Comparing the expressions
introduce the
(1
+
q)
Ahu -
technology, the
(27)
new technology with an
p)
shows that the firm
unskilled worker
intuition
—
/?)
not binding.
will find it profitable to
P)aAh^-k> PAK-w.
than for the unregulated economy
(1
is
if
(28)
is
economy to adopt new technologies with
new technology when
(27)
meant that the minimum wage was binding
(24), wliich
the condition for this
restrictive
k)
minimum wage
immediately ensures that the right hand-side of (28)
ers, also
The
new
and
(26)
{1Assumption
unskilled
given by
J[x^l,K) = b{[lbecause,
new technology with an
value of the firm that adopts the
aAhu —
k
>
(recall the
work-
for unskilled
negative. Consequently,
unskilled workers
is less
unregulated economy adopts the
0).
as foUows: the institutions already force the firm to pay an unskilled
is
worker a higher wage than what the firm and the worker would have bargained
impMes that the firm can invest more and increase production, without
Wage compression
productivity being translated into higher wages.
is
to.
This
this increased
therefore
making
the firm the residual claimant of the increase in the productivity of the worker.
This reasoning
is
similar to the intuition for
why
firms find
it
profitable to invest in
the general training of their employees in the presence of labor market imperfections in
Acemoglu and Pischke
(1999).
Also as in Acemoglu and Pischke (1999), labor market
rents for firms are crucial for this result.
for firms,
if
institutions
With
/?
=
1,
that
is,
when
there are no rents
pushed the wages of unskilled workers up, firms would lay
off all
unskilled workers.'^
Now
imagine a situation in which firms invest in new technology with both skilled
and unskilled workers, even
in the
in the absence of the
"European" equilibrium
workers.
minimum
will also invest in
wage. Then, a
fortiori, firms
new technology with both types
of
Next, as discussed in subsection 5.3, imagine a change in technology' regime
'^Of course,
in this case
we
also
need 7
=
for firms to
24
break even in the
first
place.
at
time T, increasing the cost of investment from kr to
the
minimmn
wage,
stop investing in the
fiixms
/cj,
snch that in the absence of
new technology with
Because the minimum wage increases the incentives to invest
unskilled workers,
continue to do
so.
it
In particular,
(1
the
quite possible that the
is
new technology
-
economy with wage compression
less skill biased in
in this
Europe than
in the U.S., but in fact, there
it
why
teclinical
change
in the U.S. over the past 20 years.
may have
Interestingly,
there less skill-biased technical change in Europe than
is
none.
is
As a
result, wliile
the
skill
premium
increases in
remains unchanged in Europe. ^^
In light of these results,
indicated similar relative
little
(29)
be adopted with unskilled workers in Europe, but not in the U.S.
simple model, not only
the U.S.,
will
if
Therefore, this model offers a possible explanation for
been
new tecknology with
oAtK - PAtK + w> k'T>{l-P) oAtK,
/?)
will
in
unskilled workers.
wage compression
interesting that the brief empirical investigation above
it is
demand
shifts in other
Anglo-Saxon comitries. Since there
is
Anglo-Saxon countries, the analysis here suggests that
in these
firms there should have no fmrther incentives to adopt
workers than U.S. finns. Relative
demand
new
technologies with unskilled
shifts in favor of skiUed
slower only in economies with significant institutional
workers should be
wage compression, such
as the
continental European economies.
Wliat about vmemployment
in the
technology regime? Since firms are
"European" equilibrium
now adopting
the
change
in the
new teclmology with both
skilled
after the
and unskilled workers, the free-entry condition becomes
V=-^ + q (0^-^°^*)
[6 (((1
-P){l +
Recall that in the absence of the
a)A-
k) [4>K
minimum wage,
+
(!-</>) K))]
firms did not find
=
it
0.
(30)
profitable to
adopt the new technology with unskilled workers, so the term in square brackets
is
lower
^*The reader might note that the assumption of rent-sharing in the U.S. economy is important for
Without rent-sharing, whenever the European economy with wage compression finds
it profitable to adopt the new technology, so will U.S. firms.
This is not essential for the overall
argument, however. It is possible to generalize (and complicate) the model such that wage compression
forces European firms to invest in new technologies with unskilled workers, even when the competitive
economy would not introduce these new technologies.
these results.
25
in (30)
(23)
than the comparable term in expression
has to be liigher than 9
unemployment more
compression
in
'
°'^*
imphed by
Europe than
in the U.S.
forcing firms to adopt
is
(30),
new
Therefore,
(23).
'
°^'
and the technology shock
The
impUed by
will increase
intuition for this result
is
that wage
technologies with unskilled workers, while
without wage compression firms would have preferred not to adopt these technologies.
This implies that wage compression reduces profits from employing unskilled workers.
may be matched with
Since each vacancy
an unskilled worker, wage
either a skilled or
compression discourages job creation in general, increasing both skilled and unskilled
This pattern of high unemployment both among the skilled and the
unemployment.
Europe
unskilled in
As a
result, the
is
'^
consistent with the broad facts.
theory presented here
is
consistent with the differential inequality
trends across countries, the differential behavior of the relative
documented
in the first part of tliis paper,
Europe increased
and with the
6
fact that
relative to that in the U.S. over the 1980s.
micro evidence supporting the underlying mechanism of
demand
But
for skills, as
unemployment
as yet, there
is
in
no
story.
tliis
Concluding Remarks
Despite the social importance of inequality trends, and their prominence in academic
debates, the economics profession currently lacks a consensus on why, over the past
several decades, inequality increased in the U.S.
and the UK, but not
in continental
Europe.
In this paper,
I
reviewed the two traditional explanations for these patterns, that
ative supply of skills increased faster in
Europe and European labor market
prevented inequality from increasing, and
I
institutions
developed a simple framework to quanti-
whether these explanations are
tatively assess
rel-
satisfactory.
I
concluded that, although
these traditional explanations accotmt for a large fraction of the differential cross-coimtry
'^Notice that
if
the model
is
unskilled workers, only unskilled
the model, under
modified so that firms can open separate vacancies for skilled and
unemployment
will increase. Nevertheless, it is
some assumptions, can generate
increases in the
workers, contrasting with standard reasoning based on the
predicts that
it is
unskilled
unemployment that should
26
unemployment
Krugman
increase.
important to see that
rates for both types of
hypothesis, which unambiguously
inequality trends, they do not provide an entirely satisfactory approach. Instead,
pears that relative
demand
Motivated by this
fact,
developed a simple theory where labor market institutions
I
Europe
also
encourage more investment
creasing the productivity of less-skilled workers. This
demand
for skills over the past 20 years in
showed that
I
this explanation
technology adoption
ap-
for skills increased differentially across countries.
creating vv^age compression in
in the
it
based on the
may have
Europe than
in teclinologies in-
led to a smaller increase
in the U.S.
effect of labor
market institutions on
consistent with the differential inequality trends, the differential
is
behavior of the relative
demand
for skills
documented
in the first part of the paper,
and
the differential behavior of unemployment rates in Europe and the U.S.
These macro facts of course do not establish that
lines,
this theory
is
and there can be many other potential theories explaining why
change
differentially across countries.
empirical avenues to pursue.
I
along the correct
relative
demands
There are therefore both important theoretical and
hope that
this
paper
will stimulate others to investigate
alternative approaches with differential degrees of skill-biased technology across countries
(resulting from differential adoption decisions).
On
fully
the empirical front, work using microdata
is
necessary to investigate more care-
whether differences in relative supplies, with similar
shifts in relative
demands, can
account for the differences in these cross-country inequality trends. Future work could
also look at
whether there
is
any
direct evidence that technical change has
biased in Europe than in the U.S.
adoption and/or at rates of
industries in
tries in
both
Europe
possibility
is
less skill
to look at the rates of teclinology
growth and capital accirmulation
in unskill-intensive
relative to similar industries in the U.S. (using skill-intensive indus-
set of countries as a control group).
direct investigation of
ers,
TFP
One
been
Alternatively, one could undertake a
whether certain advanced technologies, such as personal comput-
computer-assisted or nmnerically-controlled machines, used seldom with unskilled
workers in the U.S., were introduced with imskilled workers in Europe. Finally,
also
be
fruitful to
it
may
use data on industry-level skill-upgrading across different countries and
expand the approach used imi Berman, Bomid and Macliin (1998)
estimates of relative
demand
shifts across countries.
27
to obtain alternative
On
why
tlie
theory front,
relative
demand
it
would be useful
for skills
including theories where the
Finally, the current
among
OECD
may have changed
economy may function
differentially in different countries,
off its relative
paper has focused on the causes of
demand
differential
document rapid increase
and a number of studies
in the
and low-income
demand
for skills in
find increasing inequality in
Freeman and Oostendorp, 2000, or
Dmyea
nations.
many
the study
Herman and Machin
developing countries
An
causes of the increase in inequality in developing countries over this
28
is
middle-income countries,
and Szekely, 2000).
an important research area.
curve.
inequahty trends
economies. Another important and potentially exciting area
of inequality trends in middle-income
(2001)
to investigate alternative explanations for
(e.g.,
investigation of the
same period
is
also
.
Data Appendix
7
The samples come from the Luxembourg Income Studies Database
is
(LIS).
The LIS data
a collection of micro datasets obtained from annual income sm'veys in various coun-
While these surveys are similar
tries.
form to the Cirrrent Population Survey
in
the United States and extensive effort has been
made
to
for
make information on income
and household characteristics comparable across countries, important problems
of
com-
parabihty remain. In order to maintain consistency across countries, several restrictive
have been used when defining variables and samples. Following Gottschalk and
criteria
Joyce (1997),
who
weighted by weeks worked,
Moreover, the data
individuals
is
LIS data, a simple count of the number of workers, not
also used
is
is
restricted to
not available for
measme
used as a
all
of sui.)ply from each educational group.
male heads of households, since the earnings of other
survey years
Comitries for which data
in all countries.
on gross wages were not available were discarded, as were data from countries with only
one survey in the LIS data base. In addition,
do not use the German surveys
uses data from Australia (1985
91, 94
and
97),
Denmark
for 1981
and
89),
(1987, 92, 95
for the reasons
and 1984. As a
Belgium (1985,
and
explained in the text, we
result, at the
88, 92
and
97), Finland (1987, 91
96),
and
end
this
study
Canada
(1987,
95),
Germany
(1989 and 94), Israel (1979, 86 and 92), the Netherlands (1983, 87, 91 and 94), Norway
(1986, 91
95).
Data
The
or
more
and
95),
for the
college
Sweden
(1981, 87, 92
United States
premimn
is,
in all
and
95), the
United Kingdom (1979, 86, 91 and
those years comes from the
generally, the coefficient
March CPSs.
on workers with a college degree
relative to high school graduates in a regression of log real annual gross wages.
Specifically, four
education categories were constructed, conceptually corresponding to
less-than 12 years of education (liigh school dropouts), 12 years (high school graduates), 13 to 15 years
U.S.
The recoding
(some
college),
into these groups
the education variable
is
measured
is
is
or
more years
(college graduates) for the
straightforward in countries and years where
in years of
Finland, at least for some years), but
the education variable
and 16
schooUng (these
are: Israel,
somewhat more problematic
already grouped
(all
29
the rest, except
Canada and
for countries
where
Sweden and the United
Kingdom) Since no education information
is
.
and the United Kingdom, returns
LIS data base
for
Sweden
to broad occupations are used rather than education.
Three occupation groups are constructed
professional
available in the
samples, roughly corresponding to
for those
and managerial workers, blue coUar workers and a residual category which
The
includes lower-level white-collar workers.
regression also includes
dummies
—
remaining education/occupation cattegories and a quartic in age
for the
since the exact
num-
ber of years of schoohng would have to be inputed for most surveys, a quartic in age,
and not experience,
is
used as a control in the wage regression. Only full-time, full-year
workers aged 18 to 64 are used in these computations.
as those
whose hours of work per week were no
defined as those
who worked
at least 48
those observations with the lowest
1
less
Full-time workers are defined
than
35,
and
The samples
weeks per year.
workers are
full->-ear
also lea\-e out
percent earnings. Finally, earnings for top coded
observations are calculated as the value of the top code times 1.5.
The
relative supply of skills is calciilated
from samples that include
salary workers between the ages of 18 and 64.
non-college equivalents
=
=
college graduates
0.5 x workers with
school dropouts. For the Netherlands,
it
some
-I-
Katz and Krueger
0.5 x workers with
college
was impossible
-t-
some
UK
high school graduates
30
+
and
liigh
to distinguish between workers
where only occupational categories were available,
used in the relative supply computations.
(1998),
college,
with some college and workers with a college degree, so for this country, as
and the
wage and
defined as the ratio of college-
Following, Autor,
equivalents to non-college equivalents.
these are: college equivalents
It is
all
onl}- tliree
for
Sweden
groups were
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34
Journal of Political
Economy
78 (1970),
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"3
Relative supply
Skill
premium
of skills
European
supply
Q)US-Post
shift
coP^^
and
E
Relative
co^-p^^'
demand
for skills
SkilPbiased tech. change
or increased trade
H/L
Figure
1:
Differential inequality trends
HVL'
due to
35
differential relative
supply changes.
Relative supply
Skill
CO
premium
of skills
US-Post
Institutional wage-setting
E
(oP^=
and
line for
Europe
coE-P°st
Relative
demand
or skills
Skill-aiased tech. change
or increased trade
Relative
unemployment
in
Figure
2:
Europe
Differential inequality trends because of differences in labor
institutions.
36
market
ill
Australia
#
-
observed
— ^—
1
1979
United Kingdom
Figure
.3a:
19B6
-
Actual
observed
skill
I
Canada - observed
premium
vs. predicted skill
togw
—4
predicted logw, eos-2
vs predicted
predfcted logw eos=2
skill
premium
pfedided togw. eos=2
1
1
1991
vs. predicted
skill
1995
premium
premia and predicted
and a
37
skill
=
2.
premia from equation
(7) for
cr
=
1.4
— predicied
O
— prwJided
togw eo5-2
logw e<»=?
predicted tog-v eos==
T-
-T
1983
Belgium
-
observed
B—— predrcted logw
vs. predicted skill
premium
— predicted
logw,
Netherlands
-
1987
199J
1991
observed vs. predicied
skill
premium
A^— predicted logw
eos=2
eos=2
eos=
_fc
?
1991
Finland
-
observed
Figure 3b: Actual
vs. predicted
skill
skill
1995
1992
Sweden obsen/ed
premium
-
premia and predicted
and
cr
38
skill
=
2.
vs. predicted
skill
premia from equation
1995
premium
(7) for
a
=
1.4
- predided logw. eos=2
1992
Denmark- observed
vs. predicted
A
Israel
-
observed vs predicted
Figure 3c: Actual
skill
skill
—B
1995
- piedided
piedicted itugw
1997
Germany
premium
observed
predided logw, eos=2
skill
logw. eos=Z
bos=-14
vs. predicted
ft
premium
Norway
premia and predicted
and a
39
skill
=
2.
-
observed
skill
premium
predided logw. eos=2
vs. predicted skill
premia from equation
premium
(7) for
a
= lA
"
Q
A
—a
ptedicled logw. eos=2
pcedicied logw.
txa=2
predidwi logw eos==1 4
1985
Australia
»
-
observed
19V9
1986
-
Figure 4a: Actual
observed
skill
Canada
premium
—^—predicted
logw
United Kingdom
1»4
1989
vs. predicted skill
logw.
1»1
vs. predicted skill
-
observed vs- predicted
skill
1997
premium
eos=2
1995
premium
premia and predicted
and a
40
skill
=
2.
premia from equation
(9) for
cr
=
1.4
—A
1955
Belgium
-
observed
——
-
observed
Figure 4b: Actual
predided logw eos-2
—ft
1988
vs. predicted
—4
Finland
predicled logw eos=2
1991
skill
Netherlands
-
observed
Sweden
premium
premia and predicted
and
(7
41
skill
=
2.
-
observed
1994
vs. predicted skill
a
predicted logw eos=2
vs. predicted skill
skill
premium
.
I
premium
pfBd»cted logw eos=2
vs. predicted skill
premium
preinia from equation (9) for
(7
—
1.4
A
—
— predicted
predicled iog/i.
eos=2
—ft
pretfKietf logw*
eQS=2
logw eos==l 4
199!
1997
1995
1997
year
Denmark
-
observed
vs. predicted
skill
- pfedided
Israel
-
observed vs predicted
Figure 4c: Actual
skill
skill
Gemiany
premium
k>gw,
-
observed
vs. predicted
eos=2
skill
premium
preilicied togw,
premium
Norway
premia and predicted
and
(7
42
skill
=
2.
-
observed
vs,
predicted
skill
premia from equation
eo5=2
premium
(9) for
a
=
1.4
iMo
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