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Karl Marx predicted a world in which technical innovation would increasingly devalue and impoverish workers, but other economists thought the opposite, that it would lead to increased wages and living standards--and the economists were right. Yet in the last three decades, the market economy has been jeopardized by a worrying phenomenon: a rise in wage inequality that has left a substantial portion of the workforce worse off despite the continuing productivity growth enjoyed by ...
Karl Marx predicted a world in which technical innovation would increasingly devalue and impoverish workers, but other economists thought the opposite, that it would lead to increased wages and living standards--and the economists were right. Yet in the last three decades, the market economy has been jeopardized by a worrying phenomenon: a rise in wage inequality that has left a substantial portion of the workforce worse off despite the continuing productivity growth enjoyed by the economy. Innovation and Inequality examines why.
Studies have firmly established a link between this worrying trend and technical change, in particular the rise of new information technologies. In Innovation and Inequality, Gilles Saint-Paul provides a synthetic theoretical analysis of the most important mechanisms by which technical progress and innovation affect the distribution of income. He discusses the conditions under which skill-biased technical change may reduce the wages of the least skilled, and how improvements in information technology allow "superstars" to increase the scale of their activity at the expense of less talented workers. He shows how the structure of demand changes as the economy becomes wealthier, in ways that may potentially harm the poorest segments of the workforce and economy. An essential text for graduate students and an indispensable resource for researchers, Innovation and Inequality reveals how different categories of workers gain or lose from innovation, and how that gain or loss crucially depends on the nature of the innovation.
In the 17th century nearly all Europe experienced revolts of the work-people against the ribbon-loom, a machine for weaving ribbons and trimmings, called in Germany Bandmühle, Schnurmühle, and Mühlenstuhl. These machines were invented in Germany. Abbé Lancellotti, in a work that appeared in Venice in 1636, but which was written in 1579, says as follows: "Anthony Müller of Danzig saw about 50 years ago in that town, a very ingenious machine, which weaves 4 to 6 pieces at once. But the Mayor being apprehensive that this invention might throw a large number of workmen on the streets, caused the inventor to be secretly strangled or drowned." In Leyden, this machine was not used till 1629; there the riots of the ribbon-weavers at length compelled the Town Council to prohibit it.
In 1768, a group of spinners broke into the home of James Hargreaves, the inventor ofthe "Spinning Jenny," a machine which was capable of doing the work of eight workers, and destroyed his machines.
In the early nineteenth century, textile workers-the Luddites-organized against the introduction of advanced machinery that made their skills redundant. This movement is described as follows on the Web page of Dr. Steve Anderson from Utah University:
For at least three hundred years the weavers from in and around the central English town of Nottingham, though commoners, enjoyed the status and rewards accorded to fine craftsmen. The weavers of Nottinghamshire produced lace and stockings that dominated the English markets and were prominent items in export trade. These products were hand made, often in the weaver's home.... In the first years of the 19th century stocking frames and the early automation of the power loom threatened this long-standing way of life.... The weavers complained bitterly that the machines made mass produced products of shamefully inferior quality. Naturally, the weavers saw the new technology as the most powerful tool of their new oppressor, the factory owner.... During a short period climaxing in the spring of 1812, inspired perhaps by the French Revolution and the writings of Thomas Paine, the weavers formed into something akin to a guerrilla army and took substantial control over the territory near Nottingham and several neighboring districts.... The Luddites often appeared at a factory in disguise and stated that they had come upon the orders of General Ned Ludd. These demands included restoration of reasonable rates of compensation, acceptable work conditions, and probably quality control. Faced by the intimidating numbers and the surprisingly disciplined actions of the Luddites, most factory owners complied, at least temporarily. Those that refused found their expensive machines wrecked.... The nonviolent period of Luddism ended at Burton's power loom mill in Lancashire on April 20, 1812. A large body of Luddites, perhaps numbering over a thousand attacked the mill, mostly with stick and rocks.... A government crackdown ensued, and many suspected Luddites were convicted, imprisoned, or hanged.
Such incidents have led to the famous controversy between Marx and Ricardo over the role of machinery. Marx forecast a world where innovation made workers ever more useless, leading to their impoverishment, along with a secular increase in the share of capital in national income. On the other hand, Ricardo and the neoclassical economists who followed him thought that innovation allowed a single worker to produce more output per unit of time, which led to an increase in wages and living standards.
The explosion in living standards over the last two centuries has proved that the neoclassicists were right, while Marx was wrong. This is why the most influential growth model used by economists is the Solow (1956) one, where the economy converges to a balanced growth path in which wages grow in line with productivity. In recent years, however, economists have documented a worrying trend toward greater wage inequality in the United States and other countries. Not only has the distribution of wages widened, but real wages have fallen for the lowest paid workers (the bottom 20%, say), despite continuing growth in GDP per capita.
A large empirical literature has studied this phenomenon and has found that the returns have increased for all the dimensions of skill: education, experience, and unobserved ability. A number of explanations have been proposed and they are detailed in the following paragraphs.
A first explanation, put forward by, for example, DiNardo et al. (1996) and Blau and Kahn (1996), ascribes the rise in inequality to an increased role for market forces, relative to institutional forces, in the determination of wages. As conservative governments came into power in the United Kingdom and the United States in 1979 and 1981, respectively, wages became more closely aligned with individual productivity, and were less determined by union contracts. This situation creates a move toward greater wage inequality because unions tend to compress wages between skill levels. On the other hand, unions tend to increase income inequality by putting some workers out of jobs, but that is not reflected in measures of wage inequality since these measures take into account only the employed. The merit of this explanation is that it accounts for the fact that inequality has not increased in countries such as France and Germany where labor-market institutions have not evolved. On the other hand, it fails to explain the fact that inequality started increasing around 1975, long before the reforms of Margaret Thatcher and Ronald Reagan were implemented.
A second explanation is that because of immigration by unskilled workers, skilled workers have become relatively scarcer in the labor market. This explanation has been discarded on the grounds that whereas immigrants tend to be less skilled than natives in the destination country, this trend is more than offset by the increase in secondary and tertiary education enrollment rates, which tends to raise the relative supply of skilled workers. Thus, it appears that the rise in wage inequality must be explained by shifts in relative demand, rather than shifts in relative supply.
A third explanation is international trade. This says that developed countries are now immersed in a world economy in which factor-price equalization prevails. The relative wages of unskilled workers are now determined by their relative scarcity worldwide, rather than within a given country. As a result, integration in the world economy should be associated with widening wage inequality in developed countries, and shrinking inequalities in developing countries. This is essentially the famous Stolper-Samuelson theorem (see Stolper and Samuelson 1941): any factor that is scarce in a given country, relative to the rest of the world, sees its return fall when the country opens up to trade. While the debate on this hypothesis is not totally settled, Lawrence and Slaughter (1993) have shown that it is inconsistent with a number of basic facts. Most notably, if international trade were the driving force for the rise in inequality, we should observe that within each firm in the West the ratio of unskilled workers to skilled workers increases. The argument is that if technology has not changed, firms are faced with a lower relative wage of the unskilled, which induces them to increase their relative input of that factor. Of course, at the aggregate level, activity is relocated away from unskilled-intensive industries toward the skilled intensive ones; the unskilled-intensive industries are faced with a fall in their prices, because of competition from less developed countries, and therefore reduce their activity. However, it remains true that within any existing firm, one should observe a greater use of unskilled workers. Indeed, the reallocation of activity toward skilled-intensive industries is the countervailing force necessary to keep the skill ratio unchanged at the aggregate level. Lawrence and Slaughter have shown that the skill ratio did not evolve in favor of unskilled workers at the firm level; on the contrary, firms increased their demand for skilled workers.
This suggests that there has been technological change that has altered the relative factor demand in favor of skilled workers-the fourth explanation. A key potential driving force has been the sharp progress in information technology, which picked up in the mid 1970s. Research has documented how computers and a number of other information and communication technologies (ICTs) are complementary with skilled labor and substitute for unskilled labor.
While the empirical research has been quite extensive, this book's ambition is to provide an analytical perspective on the effects of technical progress on the distribution of income. I hope to show that these effects are pervasive, and that one cannot simply think of "information technology" as a black box that just shifts the relative demand of one category of workers.
This book studies how different categories of workers gain or lose from innovation, and it shows that this crucially depends on the nature of innovation. In particular, one must consider the following questions:
Does innovation increase the efficiency of physical capital, human capital, or labor?
Does innovation affect the way workers interact with each other, for example by making it easier to communicate and to access knowledge, or by changing the number of people affected by a given worker's activity?
Does innovation affect the way the economy is organized? For example, how is the hierarchical structure of the workplace changed? Is the allocation of resources to different stages of production affected?
Is innovation "vertical" (increasing productivity in existing goods) or "horizontal" (increasing the range of available goods)?
Another important methodological aspect is how we think of the labor market. In macroeconomics, one typically assumes that labor can be reduced to a vector of homogeneous inputs in the production function. Thus, production depends on the aggregate input of raw labor, human capital, and perhaps more detailed things such as beauty, strength, health, etc. This means that an individual endowed with, say, 0.6 units of strength and 0.4 units of intelligence would earn 0.6[w.sub.S] + 0.4[w.sub.I], where [w.sub.S] is the market price of strength and [w.sub.I] is the market price of intelligence. Another individual endowed with 1 unit of strength and 0.7 units of intelligence would earn [w.sub.S] + 0.7[w.sub.I]. Furthermore, the first individual might just decide to save on his or her strength and intelligence and just supply half of them, then earning 0.3[w.sub.S] + 0.2[w.sub.I]. This is what we can call the "homogeneous-input" view of the labor market. Many labor markets do not work in this way, in that individuals are actually unique and not reducible to a fungible vector of characteristics. One cannot be a part-time professional footballer, for example. Nor can one replace a good professional footballer with two bad ones. And an intelligent footballer cannot supply his football skills to Manchester United and his intelligence to MacKinsey at the same time. This can be referred to as the "quality-input" view of the labor market.
This book shows that the effect of technology on the distribution of income differs greatly according to which of these two views of the labor market one takes.
Under the homogeneous-input view, what is important is the degree of substitutability and complementarity between technology and the different inputs in the production function. Technology harms substitute factors and benefits complementary factors. In the long run, additional effects arise from the fact that some factors (such as physical and human capital) can be accumulated. For example, technology may be detrimental to labor and beneficial to capital if it is substitutable with labor, i.e., if it is equivalent to an increase in the labor input. But this increases the return to capital, which induces people to accumulate more capital, which in turn boosts wages. One can show that under standard (but not necessarily correct) assumptions, wages cannot then fall in the long run.
Under the quality-input view, a key aspect is the extent to which high-quality individuals can spread their talent over a larger market. For a footballer, this might mean having more viewers thanks to satellite television. For a manager, it might mean supervising more people by means of e-mail and video conferencing. For an accounting consultant, it might mean embodying his knowledge in a piece of software that can be distributed to millions of clients. A recurring theme is that technical progress does not then harm the poorest, because they are not substitutes for quality workers. Rather, they can watch better football, are supervised by better managers, and are more productive because their firm, thanks to the new software, accesses better accounting services at a lower cost. Those who suffer are those who are at the bottom of the ability distribution of quality workers, say the average accountant who cannot compete with the new software and is displaced to another occupation-presumably one where individual quality is less important and where the labor input is more homogeneous.
Chapters 2-5 discuss the impact of technology on wages if labor inputs are homogeneous. I start with simple neoclassical growth models, comparing the short-run effects with the long-run effects, and then move to more complex models with three factors of production: labor, human capital, and physical capital. I also distinguish between technical change as a shift to a single production function for the economy and technical change as the introduction of a new technology, summarized by an alternative production function, which may be used along with the old technology. I discuss the possibility of counterintuitive supply effects: for instance, the fact that an increase in the supply of human capital may trigger a rise, rather than a fall, in its return, because more use is made of technologies intensive in that factor.
Chapters 6-8 analyze the impact of technical change when labor is a quality input. I focus on two key phenomena. First, more talented individuals can spread their talent over a larger market-"The Economics of Superstars." Technical change then affects the relative "market size" for two individuals with different skills, which in turn has an effect on the distribution of income. Second, a worker's quality affects the productivity of his or her coworkers. These interactions within the firm determine its willingness to pay for workers of different quality. It also affects the way workers of different quality are matched together. Depending on the technology, workers of similar qualities are matched in the same firms-a segregated outcome-or firms hire workers with heterogeneous skills-a "unitary" outcome. Technical change has an effect on both the nature and the size of the interactions between the workers, and then again on both the pattern of segregation and the distribution of income.
Excerpted from Innovation and Inequality by G. Saint-Paul
Copyright © 2008 by Princeton University Press. Excerpted by permission.
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Chapter 1: Which Tools Do We Need? 1
1.1 Production and Factor Prices 2
1.2 Factor Prices and Income Distribution 6
1.3 Factor Accumulation 11
1.4 Endogenous Technical Change 15
Chapter 2: Productivity and Wages in Neoclassical Growth Models 23
2.1 The Short Run 25
2.2 The Long Run 26
2.3 Conclusion 31
Chapter 3: Heterogeneous Labor 32
3.1 Skill-Biased Technical Progress 32
3.2 Capital-Skill Complementarity 35
3.3 Unbalanced Growth 38
3.4 Conclusion 41
Chapter 4: Competing Technologies 42
4.1 Learning the New Technology Is Costly 43
4.2 The New Technology Has Different Factor Intensities 52
4.3 Asymmetric Technical Progress 54
4.4 Conclusion 56
Chapter 5: Supply Effects 57
5.1 Supply Effects and Competing Technologies 58
5.2 Induced Bias in Innovation 72
5.3 Conclusion 84
Chapter 6: Labor as a Quality Input: Skill Aggregation and Sectoral Segregation 85
6.1 Bundling and Pricing of Labor Market Characteristics 86
6.2 Conclusion 98
Chapter 7: The Economics of Superstars 99
7.1 A Simple Model 100
7.2 Occupational Choice and Displacement 103
7.3 Growth and the Allocation of Talent 108
7.4 Hierarchy and Span of Control 109
7.5 Conclusion 116
Chapter 8: Complementarities and Segregation by Skills 117
8.1 A Simple Model 117
8.2 Application: Household Income Inequality and Assortative Mating 125
8.3 Extension: Increasing Firm Size and the Number of Worker Types in Segregated Equilibria 127
8.4 Aggregating Individual Interactions 131
8.5 Conclusion 148
8.6 Appendix 148
Chapter 9: Demand Effects 152
9.1 The Isoelastic Benchmark 153
9.2 Nonhomothetic Utility 154
9.3 The Limited Needs Property 155
9.4 Dynamics: Growth and the Introduction of New Varieties 158
9.5 An Application to Globalization 163
9.6 Asymmetries between Goods 165
9.7 Conclusion 171
9.8 Appendix 172
Chapter 10: Nonhomothetic Preferences and the Distributive Effects of Innovation and Intellectual Property 174
10.1 The Social Welfare Problem 175
10.2 Second-Best Analysis: The Role of Intellectual Property 179
10.3 Conclusion 182
10.4 Appendix: Derivation of (10.11) 183