Nick Bloom, Stanford University, Labor Topics, Spring LABOR TOPICS Nick Bloom Skill Biased Technical Change (SBTC)

Nick Bloom, Stanford University, Labor Topics, Spring Why care about skill-biased technical change? (A) It is a major topic in the literature – over 100 papers in the last two decades. Hence, fantastic motivation if you can link your work to this. (B) There are a number of outstanding questions on this that careful micro-data work can address – hence fertile research area. (C) Key political phenomena – Governments around the world have faced criticism that their economic policies have increased the distribution of earnings (or employment). SBTC is the leading explanation for this

Nick Bloom, Stanford University, Labor Topics, Spring Why this SBTC occurred SBTC caused this change in inequality Changes in wage equality

Nick Bloom, Stanford University, Labor Topics, Spring Wage inequality has been rising over time Source: Autor, Katz and Kearney (2008, RESTAT)

Nick Bloom, Stanford University, Labor Topics, Spring This occurred particularly strongly from the 1980s onwards (although slowed somewhat in 1990s) Source: Autor, Katz and Kearney (2008, RESTAT) Note: The CPS data is available both from the NBER data section and also from the Michigan IPUMS data site. Both are well worth checking out

Nick Bloom, Stanford University, Labor Topics, Spring This increase in inequality was particularly a phenomena of top half of the earnings distribution Source: Autor, Katz and Kearney (2008, RESTAT)

Nick Bloom, Stanford University, Labor Topics, Spring This increase in inequality maps closely to educational achievement Source: Autor, Katz and Kearney (2008, RESTAT) In a standard Mincerian regression the returns to a year of education rose from about 7.5% in 1980 to about 10% by 1995.

Nick Bloom, Stanford University, Labor Topics, Spring At the same time the supply of ‘skills’ has increased Source: Acemoglu (2002, JEL)

Nick Bloom, Stanford University, Labor Topics, Spring There has also been an increase in residual inequality Source: Acemoglu (2002, JEL) Residual inequality is the variance of the error term (e i,t ) from a Mincer wage equation:Log(w i,t ) = α+βX i,t +e i,t

Nick Bloom, Stanford University, Labor Topics, Spring The international evidence SBTC seems to have afflicted both global superpower nations The UK experienced similar wage trends as the US Canada and Australia also experienced a similar phenomena Across Europe there has been a more moderate wage experience – but typically more inequality in unemployment This seems to be consistent with the idea that institutions constrained wages changes in Europe so movements in unemployment occur instead

Nick Bloom, Stanford University, Labor Topics, Spring Why this SBTC occurred SBTC caused this change in inequality Changes in wage equality

Nick Bloom, Stanford University, Labor Topics, Spring What has caused this within and between group changes in inequality? A summary response (1)Technology changes in much of the 20 th century have been skill biased (2)This SBTC appears to have accelerated since the 1970s (3)The supply of skilled workers accelerated in the 1970s but slowed from the 1980s onwards Thus, skills demand has outstripped supply, particularly since the 1980s, raising between group (high/low education) inequality The same phenomena has also probably also occurred for unmeasured skills, raising within group inequality from 1970s onwards

Nick Bloom, Stanford University, Labor Topics, Spring Why has technology been skilled biased (1/2)? There is no need for technological changes to be skill biased The industrial revolution in England increased in use of factories employing low skilled workers at the expense of craftsmen Luddite rebellions of 1811 and 1812 were in response to falling wages of skilled weavers as factories replaced traditional weaving A destroyer of 1800s weaving technology A destroyer of 2000s computer technology? Bill Gates

Nick Bloom, Stanford University, Labor Topics, Spring Why has technology been skilled biased (2/2)? The support for 20 th Century SBTC is empirical – there has been a massive increase in the supply of skills (educated workers) at the same time as skilled wages has risen relatively since 1970s. This has happened in every sector of the economy – so a universal rise in both the quantity and price of skills. This must be a demand shift Evidence that SBTC occurred earlier in the century due to electrification (Goldin & Katz, 1998)

Nick Bloom, Stanford University, Labor Topics, Spring Over the 20 th century skills premia has fluctuated Source: Goldin & Katz (2007) Variation in returns mainly due to change in relative supply of skilled and unskilled workers

Nick Bloom, Stanford University, Labor Topics, Spring Modeling the increase in returns to skills The traditional Solow model is skill neutral in technical change: Y=AK α L β H γ But the prior evidence suggests a strong skill biased component.

Nick Bloom, Stanford University, Labor Topics, Spring Skill Biased Technical Change (SBTC) Can extend the Solow model to for skilled and unskilled labor L=[(A s L s ) σ + (A u L u ) σ ] 1/σ, σ<1 SBTC in this setup would be the ratio A s /A u rising over time Can substitute into a production function & re-arrange in terms of wage premium. Katz and Murphy (1992, QJE) did this and estimated the following regression implied by this production function (HS=high school, C=college): Ln(W C /W HS )= β 0 + β 1 (L C /L HS ) + D t + e t They found β 1 ≈-2/3 and D t about 2.5% (2% on figures updated to 2005) Suggests that labor supply clearly matters, but there has been a steady trend favoring skilled labor over the last 40 years.

Nick Bloom, Stanford University, Labor Topics, Spring Katz & Murphy (1992) results (updated by AKK 2007) Source: Autor, Katz and Kearney (2008, RESTAT) Skill rose strongly in 1970s because: Vietnam draft laws Higher education expansion interacting with post-war baby boom Can see 1970s rise in skills supply and fall in relative skilled wages against long-run trend Long-run trend from 1970s onwards shows strong pro-skills wage drift Need to interpret cautiously, though, as only about 40 observations with serially correlated errors

Nick Bloom, Stanford University, Labor Topics, Spring Why this SBTC occurred SBTC caused this change in inequality Changes in wage equality

Nick Bloom, Stanford University, Labor Topics, Spring Why did this SBTC occur - summary? (1)Proximate cause appears to be cheaper capital and/or computers (2)But why is this skill-biased? Several arguments: a)Skills directly complement capital b)Skills directly complements computers c)Skills needed for rapid change – post 1970s had rapid change (3)Other factors that appear to play an additional (more minor) role: Labor market institutions (minimum wage and Unions) Trade with developing countries, e.g. China (4)But why did capital (particularly PCs) become cheaper? One view is the direction of technology is endogenous – the rise in skills promoted SBTC to occur

Nick Bloom, Stanford University, Labor Topics, Spring (a) Capital complementarity (1/2) One plausible idea is that capital is more complementary to skilled labor then unskilled labor. Krussell, Ohanian, Rios-Rull and Violante (2000, Econometrica) Y=K α (λ[μK s ρ + (1-μ)L s ρ ] σ/ρ + (1- λ )L u σ ) 1/σ If σ>ρ then reductions in the cost of K increase the demand for L s Effectively this replaces A s /A u with the price of capital

Nick Bloom, Stanford University, Labor Topics, Spring (a) Capital complementarity (2/2) Krussell et al. (2000) then provide evidence for a long-run fall in the cost of capital providing results for the model matching the data So neat model and plausible results. But there is an identification problem as the impact of the cost of capital is killed by a time trend (Acemoglu (2002, JEL), so can not be certain.

Nick Bloom, Stanford University, Labor Topics, Spring (b) Computer capital complementarity (1/3) Worker-level evidence Krueger (2003) shows that people using computers earn higher wages, and this wage premium has increased over time. Consistent with computers playing an important role, but also with computers proxying unobserved skills – for example DiNardo and Pischke (1997) show similar phenomena is true for pencils. Computers or pencils?

Nick Bloom, Stanford University, Labor Topics, Spring (b) Computer capital complementarity (2/3) Industry level evidence A number of papers also show that: All industries show an increase in skills demand and skill premium This rise is faster in industries increasing computerization faster The drawback to this evidence is that: Unobserved – could have been something else driving both Increase in computerization in the 1980s also predicts skills premium increases in the 1960s In summary, appears likely computerization is strongly linked with SBTC, but hard to prove definitively

Nick Bloom, Stanford University, Labor Topics, Spring (b) Computer capital complementarity (3/3) Most recently Autor, Levy and Murnrane (2003) use the Dictionary of Occupational Titles to allocate cognitive and manual repetitive and non- repetitive tasks to jobs Idea is repetitive tasks can be replaced by computers, non- repetitive ones can not Find that wages and employment in repetitive tasks fallen fastest – leading to a polarization of employment: “lovely and lousy jobs” as christened by Goos and Manning (2008) for the UK Michaels, Natraj and van Reenen (2010) show similar polarization results for the UK, US and 9 other OECD countries

Nick Bloom, Stanford University, Labor Topics, Spring Source: Autor, Katz and Kearney (2007, RESTAT) Evidence that employment is polarizing since the early 1990s – employment growth strongest below 30 th percentile above the 75th The polarization of employment

Nick Bloom, Stanford University, Labor Topics, Spring (c) Skills are needed to deal with change The Nelson and Phelps (1966) hypothesis is that change is complex and skilled people are better at dealing with this The “acceleration hypothesis” Consistent with evidence that higher skilled employees are increasingly in demand as firms rapidly changing technologies Problems are that periods of 1970 to 1995 are associated with sluggish TFP growth – hard to reconcile this with radical technological change So in summary seems plausible but hard to fully pin down

Nick Bloom, Stanford University, Labor Topics, Spring What about other factors – trade unions? Trade unions have been weakening since the 1970s while the absolute level of the minimum wage fell strongly in the 1980s This almost certainly played a role in the particularly poor performance of the lowest earnings quartile in the 1980s. But: unions weakened only in the 1980s while the changes in inequality started in the 1970s unions more likely to effect the bottom half, while top quartile is where most of the action was

Nick Bloom, Stanford University, Labor Topics, Spring What about other factors – minimum wage? Real value of the minimum wage fell throughout the 1980s as this was not indexed and frequently not updated. This almost certainly played a role in particularly poor performance on the lowest quartile in the 1980s. But problems with MW as a complete story: Impact mainly in bottom quartile MW only started to decline in real-value in 1980s Other countries – like the UK – had no MW until late 1990s

Nick Bloom, Stanford University, Labor Topics, Spring What about other factors – international trade? Trade from China, India and other countries could also play a role? Literature generally discounts this as a major force as skill levels and high-skilled wages have risen in almost every industry (including all the non-tradable sectors) – e.g. Berman, Bound and Griliches (1994, QJE) The basic Hecksher-Olin model would not predict this But: Could possibly be due to outsourcing within non-tradable industries More generally the empirical evidence is primarily in late 1990s before Chinese imports really took off. Since then entire industries have virtually disappeared (furniture, toys, textiles etc..) So trade is potentially an increasingly big factor, but there is very little recent evidence on this

Nick Bloom, Stanford University, Labor Topics, Spring Endogeneous technical change Final question is why did SBTC occur in the 1970s? Acemoglu and others have a number of papers around the idea of endogenous technical change – idea that increased supply of graduates led to technical change Related idea is endogenous technical adoption – different countries adopt different technologies endogenously An interesting area of research and plausible hypothesis with again very limited empirical evidence