The Effects of Technical Change on Labor Market Inequalities

The Effects of Technical Change on Labor Market Inequalities Andreas Hornstein (Richmond Fed) Per Krusell (Princeton University) Gianluca Violante (New York University) Sannäs, August 3 5, 2005 Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 1/19

What do we do in the Handbook chapter? 1. We discuss three decades (1970-2000) of data on technology, productivity, and labor market outcomes Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 2/19

What do we do in the Handbook chapter? 1. We discuss three decades (1970-2000) of data on technology, productivity, and labor market outcomes 2. We explore the hypothesis that technological change has determined the observed changes in the labor market (and that there may be a feedback) Neoclassical theory: competitive labor market, firms as production functions Beyond neoclassical theory: frictional labor market, organization of firms, unemployment, institutions (e.g. unions) Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 2/19

What do we do in the Handbook chapter? 1. We discuss three decades (1970-2000) of data on technology, productivity, and labor market outcomes 2. We explore the hypothesis that technological change has determined the observed changes in the labor market (and that there may be a feedback) Neoclassical theory: competitive labor market, firms as production functions Beyond neoclassical theory: frictional labor market, organization of firms, unemployment, institutions (e.g. unions) 3. We, briefly, speculate on the macroeconomic, welfare and policy implications of technology-induced changes in the wage structure Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 2/19

Methodological Issues Distinctive feature of this literature: huge variety of approaches Neoclassical growth/schumpeterian growth, McCall search/lucas-prescott islands, Mortensen-Pissarides random matching/directed search, Bewley incomplete markets/arrow-debreu with limited commitment Why such heterogeneity of frameworks? 1. Young field of research 2. Many possible departures from competitive model Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 3/19

Methodological Issues Distinctive feature of this literature: huge variety of approaches Neoclassical growth/schumpeterian growth, McCall search/lucas-prescott islands, Mortensen-Pissarides random matching/directed search, Bewley incomplete markets/arrow-debreu with limited commitment Why such heterogeneity of frameworks? 1. Young field of research 2. Many possible departures from competitive model Challenge for the exposition... we gave priority to presenting a wide range of ideas, at the cost of often simplifying models Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 3/19

College-High School Wage Premium 1.6 Dynamics of Relative Prices and Quantity of Skills in the U.S. (1963 2002) Normalized ratios (1982=1) 1.4 1.2 1 0.8 0.6 0.4 Wage Premium: 1.47 Relative Supply: 0.88 Wage Premium COLG HSG Relative Proportion COLG HSG 0.2 1965 1970 1975 1980 1985 1990 1995 2000 Year Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 4/19

Rise in the Educational Premium I KATZ-MURPHY (1992) From CES production function in skilled and unskilled labor: ( wst ) ( Ast ) ( lut ) log w ut = σlog A ut + (1 σ)log l st Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 5/19

Rise in the Educational Premium I KATZ-MURPHY (1992) From CES production function in skilled and unskilled labor: ( wst ) ( Ast ) ( lut ) log w ut = σlog A ut + (1 σ)log l st σ = 0.3 elasticity of substitution around 1.4 relative supply of skills rose at 3% per year skill-biased technical change (SBTC) grew at 10% per year Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 5/19

Rise in the Educational Premium I KATZ-MURPHY (1992) From CES production function in skilled and unskilled labor: ( wst ) ( Ast ) ( lut ) log w ut = σlog A ut + (1 σ)log l st σ = 0.3 elasticity of substitution around 1.4 relative supply of skills rose at 3% per year skill-biased technical change (SBTC) grew at 10% per year Limits of the pure SBTC hypothesis: it s based on an unobservable residual growth in relative productivity of skilled labor huge, plausible? SBTC exogenous Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 5/19

Rise in the Educational Premium II GRILICHES (1969), HOLMES-MITCHELL (2004), JOVANOVIC (1998), KRUSELL-OHANIAN-RIOS RULL-VIOLANTE (2000) Capital-skill complementarity hypothesis: Capital equipment and skilled labor are complements in production Rapid fall of relative price of equipment, due to fast productivity improvements in ICT, increased the demand for capital in production It successfully accounts for the rise in the skill premium, essentially without the help of growth in the unobserved relative productivity of skilled labor. Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 6/19

Further Evidence on K-S Complementarity FLUG-HERCOWITZ (2000), GOLDIN-KATZ (1998), LINDQUIST (2003, 2004), COEN PIRANI-CASTRO (2004) Large effect of equipment investments on relative wages in a cross-section of countries The theory works also when applied to the evolution of skill premia in Sweden, where institutions play a big role in the labor market It helps explaining cyclical behavior of the skill premium at business-cycle frequencies Suggestive historical evidence... Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 7/19

Historical Role of K-S Complementarity 1.4 Dynamics of Relative Prices of Capital and Returns to Education in the U.S. (1929 1995) 1.3 Relative Relative Price Price of Capital of Capital Return Return to College to College Return Return to High School to 1.2 Normalized ratios (1929=1) 1.1 1 0.9 0.8 1929 = 0.10 1929 = 0.095 0.7 0.6 0.5 1930 1940 1950 1960 1970 1980 1990 Year Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 8/19

Endogenous Skill-Bias SAMUELSON (1965), ACEMOGLU (1998, 2002, 2003), KILEY (1999), COZZI-IMPULLITTI (2004) If R-D can be directed towards productivity improvements of different inputs, it will be biased towards the one with the highest return for the innovators Sources of SBTC: 1. market size effect: Exogenous rise in the supply of skilled labor in 1970s Technology policy: U.S. government shifted expenditures towards IT goods 2. relative price effect: Openness to trade Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 9/19

Rise in the Returns to Ability CASELLI (1999), GALOR-MOAV (2000), GALOR-TSIDDON (1997), GREENWOOD-YORUKOGLU (1997), KRUEGER-KUMAR (2004), LLOYD-ELLIS (1999) Nelson-Phelps (1966) Hypothesis: workers endowed with more innate skills cope better with technological transformations Various versions: more able workers...... are more productive with the new technology... acquire skills specific to the new technology more cheaply... are less subject to obsolescence of human capital due to the introduction of new technologies Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 10/19

Returns to Experience by Educational Group Male high school graduates 0.65 0.6 0.55 0.5 0.45 0.4 0.35 0.3 60 65 70 75 80 85 90 95 Male college graduates 0.65 0.6 0.55 0.5 0.45 0.4 0.35 0.3 60 65 70 75 80 85 90 95 Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 11/19

Rise in the Experience Premium AGHION-HOWITT-VIOLANTE (2002), HECKMAN, LOCHNER AND TABER (1998), WEINBERG (1999) General Purpose Technology: transferability of knowledge improves with GPT, which increases the value of experience and the returns to experience Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 12/19

Rise in the Experience Premium AGHION-HOWITT-VIOLANTE (2002), HECKMAN, LOCHNER AND TABER (1998), WEINBERG (1999) General Purpose Technology: transferability of knowledge improves with GPT, which increases the value of experience and the returns to experience Experience facilitates adoption for the low-educated: experience plays the role of education/ability for the unskilled workers Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 12/19

Age-Profiles of PC Adoption Fraction of Workers 0.4 0.35 0.3 0.25 0.2 0.15 1984 1987 1993 1997 Adoption Rate of Computers by High School Graduates 0.1 0.05 0 5 10 15 20 25 30 35 40 Years of Experience 1 Adoption Rate of Computers by College Graduates Fraction of Workers 0.9 0.8 0.7 0.6 0.5 0.4 1984 1987 0.3 1993 1997 0.2 0 5 10 15 20 25 30 35 40 Years of Experience Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 13/19

Deunionization and the Rise in Inequality UNITED STATES: 65-92 0.32 4.0 0.30 union density 0.28 0.26 0.24 0.22 3.5 3.0 2.5 90-10 wage differential 0.20 0.18 2.0 66 68 70 72 74 76 78 80 82 84 86 88 90 92 unionization inequality Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 14/19

Deunionization ACEMOGLU-AGHION-VIOLANTE (2002), ORTIGUEIRA (2004) Traditional view: deunionization is an alternative explanation Alternative view: deunionization is caused by technology Model the union as a coalition of workers heterogeneous in their skill level, with endogenous participation decision: Benefit: rent extraction Costs: wage compression for skilled workers, operating cost SBTC increases the relative productivity of skilled workers and the value of opting out of the union to work at the competitive wage SBTC deunionization which amplifies the direct effect of SBTC on inequality, by eliminating wage compression Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 15/19

Rise in the Returns to Luck ACEMOGLU (2002), MANUELLI (2000), SHI (2002), VIOLANTE (2002), WONG (2003) Models with frictional labor markets, random matching, vintage capital, and Nash bargaining An acceleration in the rate of capital-embodied technical change has two effects: 1. can increase the dispersion of productivities of technologies in operation higher wage inequality, since wages depend on productivity of machines Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 16/19

Rise in the Returns to Luck ACEMOGLU (2002), MANUELLI (2000), SHI (2002), VIOLANTE (2002), WONG (2003) Models with frictional labor markets, random matching, vintage capital, and Nash bargaining An acceleration in the rate of capital-embodied technical change has two effects: 1. can increase the dispersion of productivities of technologies in operation higher wage inequality, since wages depend on productivity of machines 2. with vintage human capital, it can increase the dispersion of skills higher wage inequality, since wages depend on individual outside option Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 16/19

Europe vs US: Unemployment and Labor Share 11 "Standardized" Unemployment Rate 76 Labor Share 10 9 United States Europe (Average) 74 Percentage 8 7 6 5 Percentage 72 70 68 4 3 66 United States Europe (Average) 2 1960 1965 1970 1975 1980 1985 1990 1995 Year 64 1960 1965 1970 1975 1980 1985 1990 1995 Year Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 17/19

Europe vs United States ACEMOGLU (2003), BERTOLA-ICHINO (1995), CABALLERO-HAMMOUR (1998), HORNSTEIN-KRUSELL-VIOLANTE (2003), LJUNGQVIST-SARGENT (1998), MARIMON-ZILIBOTTI (1999), MORTENSEN-PISSARIDES (1998), ROGERSON (2004) Krugman s (1994) hypothesis: similar macroeconomic shocks, interacted with different institutions lead to different outcomes Labor supply view: technology shock skill obsolescence reduces earning power jobless workers prefer collecting UI to working at the low wage u rises Labor demand view: K-embodied technology shock labor becomes too expensive relative to capital due to wage rigidity capital substitutes labor in production Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 18/19

Europe vs United States ACEMOGLU (2003), BERTOLA-ICHINO (1995), CABALLERO-HAMMOUR (1998), HORNSTEIN-KRUSELL-VIOLANTE (2003), LJUNGQVIST-SARGENT (1998), MARIMON-ZILIBOTTI (1999), MORTENSEN-PISSARIDES (1998), ROGERSON (2004) Krugman s (1994) hypothesis: similar macroeconomic shocks, interacted with different institutions lead to different outcomes Labor supply view: technology shock skill obsolescence reduces earning power jobless workers prefer collecting UI to working at the low wage u rises Labor demand view: K-embodied technology shock labor becomes too expensive relative to capital due to wage rigidity capital substitutes labor in production Sectoral-transformation view: if one focuses on e (rather than on u), the US-EU trends start diverging in the 1960s differential expansion of service sector. Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 18/19

Policy Implications HECKMAN-CARNEIRO (2004), KRUEGER (2004) To the extent that the impact of technological change on inequality is socially inefficient, we can speculate on the best policy Technology-skill complementarity important to rebuild (obsolete) skills through training policies Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 19/19

Policy Implications HECKMAN-CARNEIRO (2004), KRUEGER (2004) To the extent that the impact of technological change on inequality is socially inefficient, we can speculate on the best policy Technology-skill complementarity important to rebuild (obsolete) skills through training policies Technology-ability complementarity interventions should occur early in the life-cycle adult training is ineffective, better subsidizing wages for the low-skilled Hornstein-Krusell-Violante, The Effects of Technical Change on Labor Market Inequalities p. 19/19