The skill premium – the wage of skilled labour relative to the wage of unskilled labour – will tend to remain stable at its current level of 58%, according to research on its evolution in Europe since 1300 by Rui Luo, to be presented at the Royal Economic Society”s annual conference at the University of Bristol in April 2017.
The skill premium declined in Western Europe from 140% to 58% in 1600. With some fluctuations, it has stuck there ever since. The author suggests that this is because of the competing effects of the ratio to capital to human capital (education and skills) employed in business, and the investment in human capital.
When there is a high level of capital compared with human capital, the skill premium goes up. But as more investment is put into human capital, leading to more skilled workers, the premium goes down. The author identifies three historical eras: initially, low levels of capital drive the skill premium down. After 1600, higher capital investment stabilises the premium. From the industrial revolution, high capital investment drives the premium up; then rapidly increasing human capital returns the premium to equilibrium.
”One policy implication of my study is that physical capital accumulation such as infrastructure development could possibly help contemporary developing countries reduce poverty and inequality”, the author says.
The skill premium is the wage of skilled labour relative to the wage of unskilled labour. It reflects wage inequality between skilled and unskilled labour. In the historical period from 1300 to 1914, the skill premium in Western Europe, the area that took an early lead in growth and modernisation, tended to decline and converge to a low level.
According to empirical studies, the average skill premium in Western Europe declined from 140% in 1300 to 58% in 1600. And from 1600 to 1914, the skill premium appears to have converged to the level of 58%, despite some fluctuations. Why the skill premium in Western Europe behaved as such is an interesting question to study.
This research answers this question by analysing the formation and evolution of the skill premium. According to this study, the capital-human capital ratio and human capital investment determine the skill premium. They have competing effects on the skill premium: an increasing capital-human capital ratio has a positive effect on the skill premium whereas an increasing human capital investment has a negative effect on it. Which effect dominates the other depends on the level of capital-human capital ratio (that is, how abundant physical capital is relative to human capital).
The author concludes that:
• When the capital-human capital ratio is low, the negative effect of the capital-human capital ratio dominates. This lowers the skill premium.
• As the capital-human capital ratio grows higher, the two effects cancel out and the skill premium remains stable.
• When the capital-human capital ratio becomes sufficiently high, the positive effect of human capital investment dominates at the beginning, causing an upward fluctuation of the skill premium. But as the capital-human capital ratio continues to grow, its negative effects on the skill premium dominate again. The skill premium then decreases back to the stable level before the fluctuation.
Economic growth is driven by the growth of the capital-human capital ratio. And the conclusion shows that for different levels of the capital-human capital ratio, the skill premium behaves in three different ways. Then as the capital-human capital ratio grows from an initially low level to a sufficiently high level, the economic growth from 1300 to 1914 can be partitioned into three regimes:
• The first regime (1300-1600) features a low level of capital-human capital ratio and slow technological progress. The negative effect of the capital-human capital ratio dominates and the growing capital-human capital ratio leads the skill premium to decline (from 140% to approximately 58%).
• In the second regime (1600-1800), technological progress is still slow, yet the capital-human capital ratio becomes higher and triggers mild growth of human capital investment. With both human capital investment and capital-human capital ratio growing over time, their competing effects cancel out, leaving the skill premium at the stationary level (say, at 58%).
• In the third regime (1800-1914), the capital-human capital ratio becomes sufficiently high. This results in an increase in human capital investment and causes an upward fluctuation of the skill premium. Technological change accelerates, which enables the capital-human capital ratio to continue growing. Then the negative impact of the growing capital-human capital ratio becomes dominant again. The skill premium then decreases back to the level in the previous regime (58%) as time goes by. This convergence of the skill premium indicates that any deviation from the previous level is temporary fluctuation.
Over the centuries, the growth of the capital-human capital ratio, while incurring economic growth in Western Europe, brings the skill premium to a low and stable level. This means that people from all working classes benefit from the growth.
One policy implication of this study is that physical capital accumulation such as infrastructure development could possibly help contemporary developing countries reduce poverty and inequality.
Skill Premium and Technological Change in the Very Long Run: 1300-1914 – Rui Luo