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European
Economic Perspectives 22
The
Full Monty
Is trade or technology
responsible for widening wage inequality in many developed economies?
New CEPR research considers the latest UK evidence.
UK workers in the
bottom 10% of the income distribution have seen almost zero real growth
in their wages over the last 20 years. In contrast, workers in the top
10% of the income distribution have had real wage increases of around
50%. Two potential causes have been cited for this widening wage
inequality: international trade and technical change. Which really is to
blame?
The view that trade is
the culprit is based on the fact that developed countries have become
increasingly open to trade with developing countries. The latter are
rich in unskilled labour, it is argued: they can supply goods where
production is ‘unskilled-intensive’, such as T-shirts from China, at
a fraction of developed country costs. Hence, unskilled wages in
developed countries must fall.
The ‘technology’
story is that there has been rapid technical change in recent decades,
especially with the widespread introduction of computers. This technical
change has been ‘skill-biased’, raising the relative productivity of
skilled workers, but reducing demand for unskilled workers and therefore
lowering their wage.
The main
counter-argument to the trade view is that only a small fraction of
goods in developed economies are internationally traded. The service
sector makes up an increasingly significant part of production – from
restaurants to haircuts to prison services – and although some
services are traded, such as financial services, the bulk are not.
And even in traded
sectors, a number of studies suggest that trade is not important. The
usual estimate for the United States is that trade explains about 20% of
the rise in inequality. For the UK, researchers have analysed changes in
product prices across industries of different skill intensities. If
there was a trade effect, they argue, one would expect the prices of
unskilled-intensive goods to fall as less developed countries start
trading on world markets. But these studies find no evidence that the
relative prices of these goods fell during the 1980s.
Other studies have
documented skill-biased technical change in a number of industries.
Plausibly, such advances seem to be related to computers: industries
with faster computer adoption have had faster skill upgrading. And much
of the economy-wide skill upgrading has been concentrated within
particular industries along with increases in the relative wages of
skilled workers. Since both the quantity and price of skilled labour has
risen, it is argued that technical change must have been skill-biased.
To see why these
arguments are flawed, recall The Full Monty, a film about a group of
unskilled ex-steelworkers in northern England. At one point, the
character Dave takes a job as a security guard in the local supermarket.
Security seems a fine example of the services that a modern economy
increasingly produces – surely a canonical case of a non-traded good.
So one might suppose that security guard wages are unaffected by trade.
But the film shows why
this reasoning is wrong. It is not explicit as to why Dave is
unemployed, but it seems likely that the local steel industry has been
forced to close because of increased competition from abroad. Such
closures create a flow of ‘Daves’, unskilled workers potentially
available as security guards, who drive down security guard wages. So
even though supermarket output is non-traded, the wages of people who
work there are still affected by trade.
The same reasoning is
true for technology. The occupation of security guard is not subject to
dramatic technical progress, so are security guard wages unaffected by
it? Once again, it depends crucially on what is happening to comparable
workers in other sectors. If technical progress is moving faster
elsewhere and if it needs more skilled workers, that again creates a
flow of ‘Daves’, reducing security guard wages in the non-traded
sector.
These arguments, while
informal, suggest a more effective way to examine the effects of trade
and technology on wages. What matters for wages is the potential flow of
workers between sectors so the question is whether technical change and
the pressure of foreign competition – measured by output prices –
are moving more in some sectors than in others. It is differences across
sectors that potentially cause wage adjustments.
Put another way, the
finding that technical change is happening within many sectors is not
informative about changes in wages: it does not indicate whether it is
happening faster in some sectors than in others – whether there is
‘sector bias’. The many studies that find technical change within
many sectors, driven perhaps by computers, are simply uninformative
about the effects on wages.
A number of more
recent studies have therefore considered the ‘sector bias’ of trade
and technology. To see the effects of sector bias on wages, consider a
fall in the price of T-shirts due to imports from abroad. This would
cause a fall in prices in the unskilled-intensive sectors relative to
the skilled-intensive sectors. The former sectors then become
unprofitable, releasing unskilled workers and/or reducing their wages in
order to restore their relative profitability.
Changes in technology
work in a similar way. Technical progress in a sector will potentially
raise profitability. If technical change occurs in the skill-intensive
sector, then skilled wages must rise so that relative profitability
falls back to its original level. If it occurs in the
unskilled-intensive sector, then unskilled wages must rise. Note that
all technical change matters since any advances might raise sector
profitability. This suggests that researchers should look at skilled,
unskilled and neutral technical change – ‘total factor
productivity’ (TFP) – to see if there is an impact on wages.
The impact of sector
bias can be summarised: if prices or TFP grow faster in the
skill-intensive sectors, then skilled wages tend to rise relative to
unskilled wages. But if prices or TFP grow faster in the
unskilled-intensive sectors, then skilled wages tend to fall relative to
unskilled wages. Thus, the appropriate empirical strategy is to examine
whether price or TFP change is more concentrated in the skill- or
unskilled-intensive sectors. This approach contrasts with studies that
seek to document whether price or technical changes are occurring within
sectors but not to compare across sectors.
A recent CEPR
Discussion Paper by Jonathan Haskel and Matthew Slaughter is one of a
handful of studies using this new approach. According to their findings
for the UK, changes in TFP in the 1980s were not concentrated in
skill-intensive sectors. Indeed, TFP changes were more or less uniform
across all sectors. So technical change could not have caused the
increase in wage inequality since it would have had to be concentrated
in skill-intensive sectors to change relative profitability and hence
set off a rise in skilled wages.
What of prices? These
researchers find that price rises were concentrated in skill-intensive
sectors and price falls in unskilled-intensive sectors. They conclude
that it was price changes that led to the changes in wage inequality.
What does all this say
about trade? Haskel and Slaughter explore the determinants of these
price and technology changes and how they relate to trade. For example,
they find that increased foreign price pressure has caused firms to
introduce new technology. But it turns out that the sector bias of this
induced technical change is concentrated in neither the skill- or
unskilled-intensive sectors. So its effect on wage inequality is small.
The researchers also
examine the extent to which price changes are due directly to foreign
trade. In an open sector such as UK manufacturing, it is likely that
domestic prices are closely related to foreign prices. Nevertheless,
there is well-documented evidence of persistent price differentials
between UK and foreign traded goods that probably reflects trade
barriers. Haskel and Slaughter therefore consider the relationship
between domestic industry price changes and industry changes in UK
import prices from the OECD, non-OECD and newly industrialized countries
(NICs). Perhaps due to the omission of trade barriers through lack of
data, they find only a weak connection: the sector bias of NIC prices
only weakly raises wage inequality.
Overall, these results
cast considerable doubt on technology being the major cause of the rise
in UK wage inequality in the 1980s. Indeed, they strongly support the
proposition that it was changes in prices. How much such price changes
are due to trade remains open to question.This article discusses
research reported in ‘Trade, Technology and UK Wage Inequality’ by
Jonathan Haskel and Matthew Slaughter, CEPR
Discussion Paper No. 2091 (March 1999). Haskel is at Queen Mary
and Westfield College, London; he is a Research Fellow in CEPR’s
Labour Economics programme
.
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