EC820M The Economics of Inequality

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EC820M The Economics of Inequality

• Professor Donal ONeill
• Economics Dept. NUIM
• Room 27 Rhetoric House Maynooth
• donal.oneill_at_nuim.ie

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Ireland in international Context
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Longer term trends
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Earnings Inequality for Full-Time, Year-Round
Workers, 1963-2003, Gini Coefficient in United
States
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Juhn, C, K. Murphy B. Pierce (1993) Wage
Inequality and the Rise in Returns to Skill,
Journal of Political Economy, June, 410-442.
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Observed and Unobserved Inequality
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Explaining the Trends
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Evidence suggest that Relative Supply of skilled
Workers has increased in Ireland
Barrett, A, John FitzGerald, Brian Nolan (2002)
Earnings inequality, returns to education and
immigration into Ireland, Labour Economics, 9
(2002) 665680.
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How much of an increase in demand is needed to
offset this?

• Katz L. and Murphy. K (1992) Change sin Relative
  Wages, 1963-1987 supply and Demand Factors,
  Quarterly Journal of Economics, Vol. 107, no. 1,
  pp. 35-78
• Autor, D, L.Katz and A. Krueger (1998) Computing
  Inequality how computers changed the Labor
  Market, Quarterly Journal of Economics, 113, pp.
  1169-1213.

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Taken from McGuinness, S, F. McGinnity and
P.OConnell (2008) Changing Returns to Education
During a Boom? The Case of Ireland, ESRI Working
Paper No. 227.
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• Two types of workers
• Skilled (H) and Unskilled (L)
• Supply is inelastic.
• Imperfect substitutes If not then relative wages
  will not depend on relative supplies.
• Elasticity of Complementarity as

If only two factors
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CES Example
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Wage Setting

• Competitive Labour Markets.
• Must be the case that skilled and unskilled
  workers are Q-complements.
• As fraction of skilled workers increase the
  wages of unskilled workers increases.
• Exercise Prove this.

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Wage Setting (Continued)
Demand Shifts
Supply Shifts
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Wage Setting (Continued)
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Bringing CES Model to the Data

• Katz and Murphy (QJE)
• Unknowns s and

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Wage Setting (Continued)
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Magnitude of Demand Shifts
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Now difference
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• Thus with an estimate of the wage premium,
  relative supplies and s we can back out the
  implied change in relative demand.
• Autor, Katz and Krueger (1998)
• Growing relative demand for skilled workers in
  every deacde except 1940s
• Clear evidence that net demand changes were
  larger over 1970-2000.
• Whether demand accelerated in 1th 1970s or
  1980s relative to prior decades depends on
  sensitivity of assumed elasticity.
• Demand deceleration in the 1990s.

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Possible reasons behind changes in Demand

• 1. Skilled Biased Technological Change
• 2. Growth in International Trade

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Skilled Biased Technological Change

• Just interpret the as measures of
  relative efficiency of both type of labour.
• Clear from our analysis that increase in
  raises the skill premium.

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International Trade

• Instead of thinking of the above set up as a 1
  good model with two factors of production think
  of it as a two good model.
• Consumer utility is defined as
• Production is linear.

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Equilibrium

• Equilibrium requires

Supply
Demand given CES Utility functions
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Relative Prices (before Trade)

• The domestic relative prices before trade of the
  skill intensive good are given by

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Wage Premium (Before Trade)

• The skill premium is the ratio of the marginal
  value product of labour of the two types of
  workers.
• With a little bit of work we can show that this
  equals

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Introduce Trade

• US starts trading with set of LDCs that have
  access to the same technology as given by AH and
  AL but have relatively more unskilled workers

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Trade (Continued)

• After trade product markets are joined so there
  will be a unique world price.
• Since technologies (and tastes) are the same the
  world supply of the two goods is given by

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Trade (continued)

• And relative prices are given by
• Why have relative prices risen ?

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Trade (continued)

• What has happened to the skill premium ?

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How important is Trade?Freeman R (1995) Are
your wages set in Beijing? Journal of Economic
Perspectives, 15-32.

• Factor content analysis.
• Try and figure out the labour content of imports
  and use this to back out implied increase in
  skill premium.
• Find changes did not displace all that many
  low-skilled workers from manufacturing (vast
  majority of unskilled workers in non-traded
  sector).

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• Price Studies
• Key insight form our analysis that the effect of
  international trade on wages works through output
  prices.
• Increases in the price of the skilled good lead
  to increase wages for skilled workers.
• Unfortunately studies suggest that the relative
  price of skill intensive goods did not increase
  significantly over this period.

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• Factor Intensities
• Our trade model was a little specialised in that
  there was no opportunity to substitute between
  factors within a good.
• More generally (MWG page 15) if price of a good
  rises (as it will after trade) the equilibrium
  price of the factor used most intensively rises
  and both industries will move to a less intensive
  use of factor 1.
• The increase in the level of outputs across
  industries will maintain employment.

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STOLPER-SAMUELSON LERNER DIAGRAM
Lets look at point A on the blue X 1 isoquant
for good X
Suppose px 1, then the value of production
along the X 1 isoquant equals 1?1 1
Lets look at another isoquant say its the
isoquant Y 0.5
This is the unit value isoquant, provided py 2
(2?0.5 1)
Y 0.5
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Lerner diagram
One unit of cost for the producer is given by
wLrK 1
In the figure this is given by a straight line
with slope w/r and intercept 1/r for K and 1/w
for L.
At any other point on the X 1 isoquant the cost
of production is higher
Similarly, for point C on the Y 0.5 isoquant
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Lerner diagram
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Stolper - Samuelson
Take a situation as depicted in the figure and
note that good X uses relatively more capital
than good Y (slope of line through origin)
As a result the isocost line touching the unit
value isoquants rotates counter-clockwise
To touch at B and C
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Stolper - Samuelson
Also note that the rise in r and the fall in w
causes a substitution away from capital in the
production of both goods X and Y
No evidence that this happened
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Stolper - Samuelson
This is The Stolper Samuelson Theorem
It generalizes to arbitrary settings in terms of
friends and enemies if the price of a final
good rises the reward to some input rises and to
some other input falls
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• What happened in LDCs after trade ?

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Back to SBTC

• Does evidence support SBTC?
• Autor, Katz and Krueger (1998) look at demand
  changes within and between industries and finds
  that most of the change was within industries.
• In addition the upskilling was greatest in
  industries that experienced the greatest rise in
  computer use.
• However see Card and DiNardo (2002) SBTC and
  rising Wage Inequality Some Problems and
  Puzzles. Journal of Labor Economics, Vol. 20,
  no. 4, 733-783.

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Institutional Factors

• Weaker Unions
• Declining Minimum Wage

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Minimum Wage in United States
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• Outsourcing
• Feenstra, R and G. Hanson (1999) The Impact of
  Outsourcing and High Technology Capital on Wages
  Estimates for the United States 1979-1990,
  Quarterly Journal of Economics 1143, pp. 907-40.
• Innovation and Trade
• Acemoglu, D (1998) Why do New Technologies
  Complement Skills? Directed Technical Change and
  Wahe Inequality, Quarterly Journal of Economics
  1134, pp. 1055-89.