Ebook Product Demand Shifts and Wage Inequality
Wage inequality increased substantially in the US and UK during the 1980s. College graduates in the US earned 41 percent more than high school graduates in 1980, by 1995 they earned 62 percent more [Autor, Katz and Krueger, 1998]. In the UK, in 1978, median wages of workers who left school after age 18 were 40 percent higher than those who left school at or before 16. By 1995 this differential had increased to over 60 percent [Machin, 1999]. Overall wage inequality also increased sharply. The 90-10 log wage differential for male workers increased from 0.9 to 1.17 from 1979 to 1994 in the UK and from 1.16 to 1.45 in the US [Autor and Katz, 1999]. At the same time the employment shares of college graduates rose from 19.2% in 1980 to 26.7% in 1996 in the US and from 8% in 1980 to 13% in 1997 in the UK. The pattern of the increase in wage inequality and the skill premium in the US and UK during the 1980s has been well documented, yet much disagreement remains about the causes of the changes. All the theories are faced with the challenge of explaining why the demand for skills accelerated and the college premium increased soon after an unprecedented increase in the supply of skills during the 1970s and the 1980s. Several explanations have been proposed to explain the shift of demand against low skilled workers, in particular: skill biased technical change, trade liberalization and deunionization.
In the skill biased technical change literature Katz and Murphy [1992] and Card and Lemieux [2000] claim that a steady growth in the relative demand for skilled workers combined with a slowing supply is at the base of the rise in wage inequality in the 80s and 90s. Other studies argue that there has been an acceleration in the relative demand for skills in the 1980s. The most popular ones are based on skill biased technical change associated with changes in production techniques [Acemoglu, 1998], organizational changes [Acemoglu 1999], the reduction of the relative price of computer services [Krusell et al., 1999] or the non linear diffusion of ”technological revolutions” [Aghion and Howitt, 1998].
The trade literature has focused instead on increased competition from developing countries. Increased trade will have an adverse effect on the demand for less skilled workers as long as import competing industries are low skill intensive and exporting industries are high skill intensive [Wood, 1996]. The trade explanation fails to be supported by the evidence. First, trade with developing countries is only a very small proportion of GDP of most industrialized countries and therefore it’s unlikely to have a big effect on wage inequality [Krugman 1995]. Second, the trade explanation implies a rise in the relative prices of skill intensive goods in developed countries, but empirical studies find little evidence of this [Sachs and Shatz, 1994; Krueger, 1997]. Third, the trade explanation is based on the relocation of labor from low skill intensive to high skill intensive sectors. However, the empirical evidence indicates that most of the shift away from the low skilled took place through within industry changes (60% to 80%) rather than through between industry changes [Berman, Bound and Griliches, 1994; Katz and Murphy, 1992].
Some other studies argue that the change in wage setting institutions such as the decline of the unions and of the real value of the minimum wage can be associated with the increase in wage inequality [DiNardo et al., 1996; Lee, 1999]. The main problem with this explanation is that in the US deunionization began much before wage inequality started to rise. In the UK deunionization began later than the rise in wage inequality.
In this paper I investigate another mechanism that can generate wage inequality. If more skilled workers demand more skill intensive goods, then an exogenous increase in relative skill supplies will also induce a shift in relative demand. If preferences are not homothetic, an increase in the relative supply of skilled workers can shift demand for final products in favor of skill intensive goods and contribute to explaining the rise in the relative demand for skills. Sectors whose technology requires a large proportion of skilled workers are increasingly important in the economy. The weight of industries such as financial services, insurance, health, education, pharmaceuticals, computers, and legal services has increased over time both in terms of wage bill share and in terms of share of total employment. If workers that enter those sectors tend to consume more of the goods produced by the same sectors, then an increase in their supply may help create additional demand for their own labor services. Part of the outward shift in the relative demand for skills can be explained by the shift in expenditure from low skill intensive goods to high skill intensive goods induced by the increase in the relative supply of skilled workers.
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