FRBSF Economic Letter
2002-23; August 9, 2002
Technical Change and the Dispersion of Wages
In the last 25 years, the wage gap in the U.S. between highly skilled
and less skilled workers has widened noticeably. For example, in 1975
the gap in average annual earnings between high school graduates and non-graduates
was 26%; by 1999, the gap was 52%. The gap widens even more when comparing
workers with advanced degrees and those with relatively little education.
This rise in inequality has led to considerable debate about the underlying
causes. This Letter reviews some of the evidence on this issue
and discusses some recent explanations relating these phenomena to another
development that has been much in the news recently, namely, an increase
in the pace of technical progress.
What the data
show
Figure 1 shows relative annual earnings from 1975 to 1999 for U.S. workers
divided according to five categories of educational levels; educational
levels commonly proxy for skill levels, which are hard to measure directly.
(Note that these data are from the Census Bureau, which redefined the
groups in 1991 to focus on degrees earned rather than years in school;
this definitional change does not alter the basic message of the data,
but it does alter the relative size of each group, as will be discussed
below.) To focus more closely on the changes in the dispersion of earnings
over time, these data have been normalized to equal 100 in 1975. While
wages in all five categories rose over the sample, the wages of skilled
workers rose noticeably more than those of less skilled workers. (These
results are confirmed by a detailed analysis of the data; see, for instance,
the influential study by Juhn, Murphy, and Pierce 1993.)
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The distribution of wages depends on the supply of different kinds of
workers relative to the demand for them. For instance, the relative wages
of workers who did not complete high school could have declined if the
number of people in this category had risen relative to the others. Figure
2 presents evidence against this explanation; it plots the number of workers
in the same five categories and again shows data normalized to 100 in
1975. The number of workers who did not finish high school actually fell
by about a third over this period, while the number of workers with college
degrees grew to more than 2½ times its original size, and the number
of workers with advanced degrees doubled. (The figure suggests that these
ratios would have been different in the absence of the change in the Census
Bureau methodology in 1991; for our purposes the most important characteristic
of the data is that the series moved in the same direction both before
and after the change in methodology.)
The fact that skilled workers' wages increased at the same time that
their number increased suggests that an increase in demand was the dominant
force behind the rising dispersion of wages in the data. Of course, the
supply of skilled labor could have risen independently of any increase
in demand; however, the wage data imply that the demand for skilled labor
has gone up by more than whatever increase in supply might have taken
place. The remainder of this Letter discusses research that assigns a
prominent role to technical change when accounting for this increase in
demand. Since the amount of research on this issue is too large to be
addressed in this Letter, I will focus on some recent work and
try to provide a flavor of the rest.
Technology
as first cause
Several studies have developed models and documented evidence to show
that the observed increase in wage dispersion has been driven by technical
change. Griliches (1969) presented one of the key concepts for studying
these issues. He assumed the existence of two kinds of labor, skilled
and unskilled, and posited that capital and skilled labor were "complements."
While this term has a precise technical meaning, for our purposes the
key implication is that an increase in the capital stock raises the productivity
of a skilled worker more than that of an unskilled worker. Given this
assumption, an increase in the stock of capital raises the demand for
skilled workers relative to unskilled workers and so pushes up the wages
of the former relative to the latter.
Based on this work, Krusell, et al. (2000) develop a model to carry out
a quantitative analysis of the skill premium (which is defined as the
average wage of skilled workers relative to that of unskilled workers).
They argue that steady improvement in the quality of capital equipment
over their 1963-1992 sample has led to a secular decline in the price
of this equipment relative to other goods in the economy. (Consider, for
example, how the price of computers has fallen relative to the price of
haircuts.) Since capital goods and skilled labor are complements, this
has pushed up the demand for skilled labor and, hence, pushed up the skill
premium. Further, there is evidence that the pace of decline of the relative
price of capital has picked up since the 1970s, which means that the skill
premium has been pushed up even further.
After defining skilled labor as workers who have at least 16 years of
education, they find that the capital-skill complementarity effect raised
the skill premium by roughly 60% over their sample. The contribution of
this component was particularly marked during the 1960s, when it raised
the skill premium by an average of 2.5% per year, and after 1980, when
it raised the premium by about 2.1% per year. They also show that in the
absence of the capital-skill complementarity effect, the increase in the
relative supply of skilled labor observed over the 1963-1992 period would
have pushed the skill premium down by about 40%.
Greenwood and Yorukoglu (1997) emphasize a somewhat different channel
through which technical progress affects wage dispersion. According to
their hypothesis, skilled workers are able to learn how to work with new
technologies more easily than unskilled workers. Therefore, periods of
rapid technical progress lead to an increase in the demand for skilled
workers, which pushes up the skill premium. Note that this hypothesis
implies that the rise in the skill premium that accompanies the introduction
of a new technology will be temporary; as time goes by, relatively low
skilled workers will learn how to work with the new technologies as well,
and the skill premium will dissipate. Thus, wage dispersion should fall
back over time.
In their model, each vintage of capital embeds the latest technology.
An increase in the pace of technical progress raises investment in capital
goods. Because skilled workers are needed to operate the new plants, every
1% increase in the capital-equipment ratio pushes up the ratio of skilled
to unskilled employment by 2.5%. As the plant ages, it is no longer profitable
to hire as many skilled workers. Greenwood and Yorukoglu find that an
increase of one year in the age of the plant reduces the share of skilled
labor in the total wage bill by roughly 0.6%.
Labor supply
as first cause
The research we have discussed so far explains the increase in the dispersion
of wages and in the number of skilled workers as a response to a change
in technology. Another strand of the literature points out that innovation
responds to economic incentives and presents models where changes in the
supply of labor trigger changes in technology and relative wages.
According to Kiley (1999), an economy with a larger share of skilled
labor offers greater incentives for developing skill-biased technologies
than an economy with a smaller share. Entrepreneurs respond to this larger
market by developing technologies that can take advantage of this skilled
labor pool. The invention of these new technologies pushes up the demand
for skilled labor and ends up raising the relative wages of skilled labor.
Kiley also shows that an increase in the supply of skilled workers leads
to the creation of more skill-biased technologies and raises the relative
wages of skilled workers in the long run. The pattern of technical change
since the mid-1970s and the rising dispersion of wages in the U.S. is
then explained as a response to an increase in the relative supply of
labor since the 1970s, "…at least in part exogenously due to
government support for higher education." (p. 720)
Acemoglu (2002) agrees with Kiley, arguing that one can understand technical
change over a long span of time by recognizing that the development and
use of technology respond to profit incentives. In one particularly interesting
example, he points out that there was a large increase in the supply of
unskilled labor in English cities during the late nineteenth century.
Among the factors responsible for this change were rapid population growth
in England, a large influx of labor from Ireland, as well as a substantial
release of labor from agriculture due to various factors. Acemoglu argues
that this led to a major increase in skill-replacing technologies, "…most
notably the factory system replacing tasks previously performed by skilled
artisans" (p. 42). He also cites some historians who have pointed
out that the absence of cheap labor may have hampered the adoption of
the factory system in the U.S. during this period. The twentieth century
represents a sharp contrast to the nineteenth, as the supply of skilled
labor has gone up rapidly, and this has led to an increase in skill-biased
technical change. Taken together, these two cases show that there is no
reason to believe that technical change tends to favor either highly skilled
or low-skilled labor; instead, the kind of change that takes place depends
upon the opportunities facing innovators.
A tentative
assessment
While economists have pointed to other factors that may have contributed
to the increased dispersion of wages we have seen over this period, available
evidence does suggest that an increase in the demand for skilled labor
that is related to recent technical change has played a significant role.
It is harder to determine how much is explained by theories that emphasize
an exogenous increase in labor supply as a first cause; while these theories
are appealing, there is little evidence yet on their quantitative importance.
Finally, from the perspective of the debate on wage dispersion, it will
be interesting to observe how the distribution of wages changes if, and
when, the recent burst in innovation tapers off.
Bharat Trehan
Research Advisor
References
[URLs accessed July 2002.]
Acemoglu, Daron. 2002. "Technical Change, Inequality, and the Labor
Market." Journal of Economic Literature 60 (March) pp. 7-72.
Census
Bureau.
Greenwood, Jeremy, and Mehmet Yorukoglu. 1997. "1974." Carnegie-Rochester
Series on Public Policy 46, pp. 49-95.
Griliches, Zvi. 1969. "Capital-Skill Complementarity." Review
of Economics and Statistics 51, pp. 465-468.
Juhn, Chinhui, Kevin M. Murphy, and Brooks Pierce. 1993. "Wage Inequality
and the Rise in Returns to Skill." The Journal of Political Economy
101 (June) pp. 410-442.
Kiley, Michael T. 1999. "The Supply of Skilled Labor and Skill-Biased
Technological Progress." The Economic Journal 109 (October)
pp. 708-724.
Krusell, Per, Lee Ohanian, Jose-Victor Rios-Rull, and Giovanni L. Violante.
2000. "Capital-Skill Complementarity and Inequality: A Macroeconomic
Analysis." Econometrica 68 (September) pp. 1029-1053.
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