Wage inequality, technology and trade: 21st century evidence

Abstract

This paper describes and explains some of the principal trends in the wage and skill distribution in recent decades. Increases in wage inequality started in the US and UK at the end of the 1970s, but are now widespread. A good fraction of this inequality trend is due to technology-related increases in the demand for skilled workers outstripping the growth of their supply. Since the early 1990s, labor markets have become more polarized with jobs in the middle third of the wage distribution shrinking and those in the bottom and top third rising. I argue that this is because computerization complements the most skilled tasks, but substitutes for routine tasks performed by middle wage occupations such as clerks, leaving the demand for the lowest skilled service tasks largely unaffected. Finally, I argue that technology is partly endogenous, for example it has been spurred by trade with China. Thus, trade does matter for changes in the labor market, but through a different mechanism than conventionally thought.

Introduction

Understanding changes in the wage distribution has been a major topic of research in labor economics over the last two decades. The stimulus for this was the huge rise in wage inequality that began in the late 1970s in the US and the UK. Adam Smith focused on human capital as an explanation for the inequality of the wage structure and the economics profession has continued in this spirit when examining recent changes.

“A man educated at the expense of much labour and time to any of those employments which require extraordinary dexterity and skill, may be compared to one of those expensive machines. The work which he learns to perform, it must be expected, over and above the usual wages of common labour, will replace to him the whole expense of his education, with at least the ordinary profits of an equally valuable capital.”¹

In this paper I revisit these classic debates in light of new evidence accumulated over the first decade of the 21st Century. I argue that the canonical demand and supply model does a reasonable job at explaining the main trends in inequality between skill groups. There has been an (ongoing) demand shift towards skilled labor which was kept in check over most of the 20th Century by increases in the supply of educated workers. It was only when the accumulation of US human capital slowed down that inequality began its secular increase in the last quarter of the 20th Century (see Goldin and Katz, 2008). Thus there is a role for both demand and supply trends in accounting for changing inequality.

Although US and UK wage inequality rose monotonically in the 1980s, since the early 1990s a better description would be “polarization”. Upper tail inequality, the ln(wage) difference between the 90th percentile and the median (the “90–50”) has continued to rise, but lower tail inequality (the “50–10” ln(wage) difference between the median and the 10th percentile) has reversed or stabilized. In all OECD countries, there has been a fall in the share of occupations in the middle of the wage distribution. Not only have high quality jobs grown (bankers, lawyers, architects and economists), so have low quality jobs in the bottom third of the wage distribution (cleaners, restaurant waiting staff, hairdressers, etc.). I argue that technology may also be the explanation here — Information and Communication Technologies (ICT) substitutes for routine tasks which were originally manual jobs (like assembly line workers), but increasingly have been non-manual jobs (like clerks). Non-routine manual jobs are largely unaffected. There is more direct and indirect evidence for this task-based explanation accumulating.

The third aspect I focus on is the need to endogenize technical change. I focus on the idea that although trade with less developed countries may not have much direct effect on inequality, it may have a large indirect effect through stimulating faster innovation and diffusion. I describe recent work which uses the growth of China as the major example of an increase in import competition with a low wage country. There is strong evidence that major shocks (such as the removal of quotas following China's accession to the World Trade Organization) have a strong effect on inducing technical change and thereby altering the structure of skill demand.

The structure of the paper is as follows. Section 2 describes some of the major changes in OECD labor markets (focusing on the US and UK) and Section 3 discusses how well these can be explained in a basic supply and demand framework. Section 4 then examines the more recent evidence on polarization since the 1990s and the task-based view of technical change that seeks to explain this trend. I discuss trade-induced technical change in Section 5 before drawing some conclusions in Section 6.

One caveat to be mentioned at the outset is that in this paper I will focus on demand–supply factors rather than labor market institutions, such as trade unions and minimum wages. This is not because I think institutions are unimportant, indeed I have written much on their relevance (e.g. Draca et al., 2011). However, in terms of these major long-term trends, many of the similarities across countries suggests to me that country-specific institutions are unlikely to be the fundamental causes of such changes, as institutions differ so much between nations. In fact the institutions themselves may adapt to changes in the economic environment.²