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Friday, September 15, 2006

Acemoglu: The Source of Rising Inequality

This NBER Reporter on technology and inequality by Daron Acemoglu is a few years old -- it's from 2003 -- but it's still very relevant. It pertains to the recent debate over the source of growing inequality and whether it is skill-based, or from other factors such as social norms and government policy.

As I've said before, unlike some who believe all of the notable change in inequality is driven by technology and changes in the returns to education, I think both technology and policy play significant roles. The section "Technology, Labor Market Institutions, and Social Norms" outlines one way for policy to play a role by linking technology to political and social factors driving inequality. The conclusion is that technological change can cause changes in the social and political environment that amplify the effect that technological change has on inequality:

Technology and Inequality, by Daron Acemoglu, NBER Reporter, Winter 2003: Many OECD economies have experienced sharp increases in wage and income inequality over the past several decades. ... Are new technologies -- in particular, computers, computer-assisted machines and robotics, and advances in communication technology -- responsible for these changes? ... Some economists now believe that, although other factors including the decline in the real value of the minimum wage, de-unionization, and globalization have played some role, the major driving force behind the changes in the U.S. wage structure is technology. ...

Although the consensus is now broad, the idea that technological advances favor more skilled workers is a 20th-century phenomenon. In 19th-century Britain, skilled artisans destroyed weaving, spinning, and threshing machines during the Luddite and Captain Swing riots, in the belief that the new machines would make their skills redundant. They were right... Products previously manufactured by skilled artisans came to be produced in factories by workers with relatively few skills, and many previously complex tasks were simplified, reducing the demand for skilled workers.

A major 19th-century technological advance, interchangeable parts, in fact was designed to be "skill-replacing" (un-skill-biased). Eli Whitney, a pioneer of interchangeable parts, described the objective of this technology as: "to substitute correct and effective operations of machinery for the skill of the artist..."

There are also no compelling theoretical reasons to expect technological change always and everywhere to be skill-biased. On the contrary, if replacing skilled workers is more profitable, new technologies may attempt to replace skilled workers... Even the most purportedly skill-biased technological advance, the microchip, can be used in scanners to complement unskilled work just as effectively as in personal computers to complement skilled workers. ...

Technology and the Recent Changes in Wage Inequality

There is general agreement among economists that technical change in the United States and the OECD over the past 60 years, or even over the past century, has been skill-biased. That is because the past 60 years have seen a large increase in the supply of more educated workers, yet returns to education have risen. In the absence of substantial skill bias in technology, the large increase in the supply of skilled workers would have depressed the skill premium... Of course here, "technology" needs to be construed broadly: it is not simply the techniques and machines available to firms, but also the organization of production, organization of labor markets, consumer tastes, and so on.

Many commentators in fact believe that there has been an acceleration in skill bias beginning in the 1970s or the 1980s. The most popular, but by no means the only, version of this hypothesis claims that there has been a notable acceleration in the skill bias of technology, driven by advances in information technology, or perhaps a "Third Industrial Revolution." ... Furthermore, during this time period the U.S. labor market also experienced a sharp increase in within-group inequality -- that is, inequality among similarly educated workers, which likely indicates the presence of some new and powerful forces. ...

Globalization and Inequality

Another major economic development of the past 30 years is the increased globalization of production.... A number of commentators have suggested that globalization and increased trade might be responsible for the rise in U.S. inequality. The arguments above -- that technological change has been important in the rise in inequality -- do not imply that other factors, such as globalization, have not played a major role. Nevertheless, most economists discount the role of globalization and trade for a variety of reasons. ...

Changes in the Organization of Production

The increase in the demand for skills and inequality in the U.S. economy may be as much attributable to the changes in the organization of production as to the direct effect of new technologies. Today's production relations, how jobs and monitoring are organized, and how firms recruit employees are all very different from 30 years ago. ...

An important driving force of the changes in production may be the increased supply of skills. When skilled workers are scarce, it is not profitable for firms to design their jobs specifically for skilled workers and to be extremely selective in their recruitment. In such a world, firms are often happy to hire many low-skill workers, train them, and employ them in relatively well-paid jobs. In contrast, in a world with many skilled workers, it pays to design jobs specifically for them and to be more selective in recruiting. This increases the productivity and pay of more skilled workers, and effectively excludes low- and medium-skilled workers from well-paid jobs.

Many of the developments in the U.S. labor market, including the recent trends in recruitment and human resource practices, the disappearance of middle-level-pay occupations, reduced training for low-skill employees, the greater dispersion in capital-labor ratios across industries, and the reduced mismatch between workers and jobs, can be explained by a theory based on an induced change in the organization of production and associated changes in recruiting strategies. Moreover, such an approach can explain the decline in the real wages of low-skill workers -- a phenomenon that pure technological theories have difficulty explaining -- because technological change, even when it is skill biased, also should increase the wages of low-skilled workers. With organizational change, though, resources will get shifted away from low-skill workers and jobs that paid them high wages will disappear.

Technology, Labor Market Institutions, and Social Norms

Emphasizing technology does not deny that changes in labor market institutions have been important. The erosion in the real value of the minimum wage and the declining role of unions undoubtedly have been important for changes in U.S. inequality, especially at the bottom of the wage distribution. In addition, the late 1980s and the1990s have seen an explosion in CEO pay, which is difficult to explain with changes in technology alone, and which suggests that there may have been concurrent changes in social norms pertaining to inequality and fairness. Why have labor market institutions and social norms related to inequality changed at about the same time that skill bias of technology accelerated? This may be a coincidence, or the overall changes in inequality may be the result of changing labor market institutions and social norms, and less the product of technology. In my view, a more fruitful approach is to acknowledge the independent effects of both changes in technology and changes in labor market institutions and social norms, and to link the two.

Recent research suggests how increases in inequality, for example attributable to technological advances, might affect labor market institutions and political preferences about redistribution. Similar arguments also might be used to link social norms of inequality and fairness to technology. Briefly, an increase in inequality might make it harder for certain labor market arrangements, like unions, to survive. Unions typically compress the wage structure, increasing the pay of less skilled workers at the expense of more skilled workers. An increase in the underlying inequality in the economy will make this more costly for high-skill workers, who then will withdraw from the union sectors and from unionized establishments.

Similarly, an increase in inequality may reduce the support that highly paid individuals give to the welfare state or to redistributive government programs. These considerations imply that technical change that increases the demand for skills can have much amplified effects on inequality, because it also will change labor market institutions and preferences towards redistribution. These forces might be amplified even more when technology also affects social norms, for example, as it becomes acceptable for CEOs to be paid much more than production workers.

Cross-country Differences

While inequality increased in English-speaking economies, there was much less of an increase in many continental European countries. To date, there is no consensus for why there was such a divergence in inequality trends among these relatively similar economies... Recent research suggests that labor market institutions compressing the structure of wages, as in many continental European economies, might induce firms to introduce additional new technologies to be used with their unskilled employees. Wage compression makes unskilled workers more expensive to employ and, conditional on wishing to employ them, it increases the value of raising their productivity.

Therefore, labor market institutions, such as binding minimum wages, union wage floors, and generous unemployment insurance programs, may have an amplified role in reducing inequality. They will do so directly and they will do so by encouraging technical change to be less skill-biased.

Overall, however, our understanding of the reasons for ... differences in inequality is weak, and much research is necessary on this topic...

I should note that Paul Krugman would not agree that the returns to education have increased in recent years, e.g. see here in particular, here, and here too, or his explanation in this email.

    Posted by on Friday, September 15, 2006 at 12:12 AM in Economics, Income Distribution, Policy, Politics, Technology | Permalink  TrackBack (0)  Comments (4)

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