An increase in the supply of skilled labour brings about an increase in the demand for skilled labour by stimulating technological progress and innovation geared towards skilled workers and educated consumers. Hence, policies that raise the supply of skilled labour – such as subsidies to higher education – raise the relative wages of skilled workers and increase wage inequality. These are the key implications of new research by Professor Michael Kiley published in the latest Economic Journal.
Kiley''s conclusion is very different from the conventional wisdom, which argues that increasing the supply of university graduates lowers the wage premium they earn and reduces the wage gap faced by workers with less than a university education. And it is far more consistent with the facts of growing wage inequality in the UK and the US since the 1970s: for example, in 1980, the average US male college graduate earned around a third more than the average high school graduate; by 1993, the wage premium for a college education had risen to more than 70%. In Kiley''s analysis, the surge in the supply of college-educated workers leads to a technological revolution. What happens is that firms engaged in research and development (R&D) attempt to create innovations that will have a large customer base. This simple insight – essentially, that supply creates its own demand – implies that R&D activities will be increasingly geared toward innovations that benefit skilled workers – or skill-biased technologies – as the supply of skilled workers rises. As a result, an economy with a rapidly growing supply of university graduates, such as either the US or the UK in the early 1970s, undergoes several changes:
- The wages of university graduates initially fall as their increased supply faces a fixed demand in the short run.
- In response to the increased supply of university graduates, R&D activities are redirected toward skill-intensive technologies – such as computers – resulting in a preponderance of new technologies being implemented by skilled workers and a large increase in the wages of university graduates.
- The technology adjustments to R&D induced by the increased supply of university graduates take time and resources, and hence the adjustments initially lead to a slowdown in productivity growth. Following the adjustments, productivity growth picks up again.
The analysis also has implications for the developing world. The US serves as a world leader in technology development, and because of its highly educated workforce, new technologies are increasingly geared towards educated workers. This skill-bias in new technologies may create a mismatch between the technologies developed in the US and the technologies suitable for less developed countries (LDCs). This may well have adverse affects for the development of LDCs.
Kiley notes that the dramatic rise in wage inequality since the 1970s in the US and the UK has been broadly similar. Economists attribute this increase in income inequality to new technologies (frequently computers) that benefit skilled workers, but they rarely consider the forces that spur innovation in technology. Kiley''s analysis generates swings in inequality and productivity growth that are broadly consistent with the rising gap between the skilled and unskilled wages, and the slowdown of output growth that followed the surge in skilled labour''s share of the labour force during the 1970s.
''The Supply of Skilled Labour and Skill-Biased Technological Progress'' by Michael Kiley is published in the October 1999 issue of the Economic Journal. Professor Kiley is at the Division of Research and Statistics at the Federal Reserve Board in Washington, DC. The views expressed in the paper are solely his own and do not reflect those of the Federal Reserve Board or its staff.