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Session7 Johnson&Topel .pdf



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Alejandra Marly
i6174306

Johnson (1997). Changes in Earning Inequality: The Role of Demand Shifts
Certain growing literature suggests that during the 1980s there was a raise in wage inequality in the United
States due to an increase in the demand for high-skilled labour. The aim of Johnson’s paper is to prove this
shift in the demand and to identify its possible explanations.
Firstly, in Table 11 we can observe that the fraction of adult population who completed college multiplied
by four in about fifty years. If demand had been stable we should have seen a decrease in relative wages,
but that is not what Table 22 shows. This table reveals the yearly average values for each variable over the
whole decade. Demand has always had an increasing trend (accelerated in the 80s) and it has been higher
than supply except for the 40s (WWII) and the 70s. This is a key decade in which relative supply more than
doubled and for once, relative wage decreased. Among different macroeconomic factors, the Vietnam War,
the Baby boom and the oil crisis are the main explanations, plus the Cobweb effect. This table comes from
the conventional supply and demand model explained by the following formula (Johnson, 1997):

In addition, if we consider Goldin and Katz’s (2007) data3, we observe that the elasticity of substitution4
() is crucial: A larger implies a demand increase, lowering the effect of inequality.

Secondly, Johnson identifies two possible explanations for this demand shift: More openness and skillbiased technological change (SBTC). However, globalisation, and the consequent outsourcing effect, does
not appear as a plausible cause as, mainly, the demand shift took place in all industries. As for SBTC, the
fact is that we have four possible technical changes6: Neutral (all workers’ efficiency is increased, so
relative wages stay the same), intensive (skilled workers are more efficient, but as unskilled workers are
complementary, both wages raise), extensive (higher demand for skilled workers and lower demand for
unskilled, increasing the wage ratio), and no SBTC (more unskilled labour is demanded, so the wage ratio
is reduced). Empirical cases imply industries experienced a relevant change in technology and specially
reduced the number of unskilled workers. Moreover, econometric analyses proved this change to be
extensive.
Finally, the clear increase of income disparity forces Johnson to question whether inequality will continue
to rise. As seen, the main cause has been a rise in the rate of extensive SBTC. Thus, we can approach this
through the demand or the supply side. Expecting future technological changes to be intensive is possible,
but not wise, as the trend of this right-shift in demand has been a long-term tendency. Confronting it with
public policies (taxes or labour market restraints) would be slow or innocuous and it could cause undesired
collateral effects. Hence, the alternative lays in modifying the supply side, specially the relative supply
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demand shifts. Therefore, to reduce inequality, the long-term effective solution is that more people go to
college and acquire the skills that the labour market demands.

1

Annex 1
Annex 2
3 Annex 3
4 That is the substitution possibilities between a skilled and an unskilled worker.
5
Meaning that it is easier to switch between skilled and unskilled workers.
6 Their effects are depicted in Annex 4.
2

1

Alejandra Marly
i6174306

Annexes
Annex 1

Source: Johnson (1997)

Annex 2

Source: Johnson (1997)

Annex 3

Source: Goldin and Katz’s (2007) in the Course Book (p. 25).

Annex 4

Source: Jointly elaborated during session 7.

2

Alejandra Marly
i6174306

Factor Proportions and Relative Wages:
The Supply-Side Determinants of Wage Inequality
Robert H. Topel
Summary
By Kalin Ognyanov, ID: i6138618
The U.S. display the highest level of wage inequality than any other OECD country.
Figure 1 below displays this inequality. We can see that the relative hourly wages of the
10th, 50th, and 90th percentile follow the same trends up until the 80-ties, where the 10th
percentile started drastically decreasing while the 90th started increasing.

Most economist describe the changes in Figure 1 as changes in the relative price of
worker’s skill, with the 90th percentile representing the high skilled workers with ever
increasing wages. Figure 2 reflects on this increase by displaying the “college wage
premium” over the same period as Figure 1. The “college wage premium” presents the
payoff for works who achieve a collage diploma compared to those who don’t.

3

Alejandra Marly
i6174306

Starting from the 80-ties onwards the “college wage premium” starts increasing
drastically. This is exactly the trend seen in Figure 1. However, in both of the figures the
trends are opposite for the 70-ties. There is a decrease in the returns to college and
inequality decreases. This due to specific elements that effect the supply of high and low
skill labour in the markets. These drivers of supply can either increase or decrease the
“college wage premium” and inequality.
The first element is Immigration, it emphasises that the increase in immigration of low
skill workers will drive wages down, especially in areas where most immigrants settle
down. However, immigration has a very small effect on inequality as immigrants
represent only a small part of the total labour force, and labour is highly mobile. The
second element is Cohort Size, which is the major reason for the opposite trends in the
70-ties. As that period is reminiscent with the “baby boom” cohort of workers entering
the labour market. Therefore, cohort size has a positive yet short lived effect on
inequality. The third element is Education, it has a positive effect on inequality, since if
higher education provides higher wages, more workers would enter the labour market
with a college diploma and decrease the college premium. However, this increase in
supply is offset by a larger increase in demand, as a result there was no decrease in wages.
The forth element is Female Labour. This theory supposes that as more women are
entering the labour market, they are competing with low skill workers and driving their

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Alejandra Marly
i6174306

wages down. However, the effect is inconclusive as some of the assumption of the theory
are counterintuitive. The fifth element is Product demand, where possible changes in
taste for product requiring high skill labour, could increase inequality, however finding
prove that the effects are very small. The sixth element is International Trade, where
the increase of imports of products requiring low skill to make, would drive wages of
native works down as their products are seen as less valuable. However, the effects are
very small. The final element is Human Capital. This theory suggest that the current
inequality will be naturally offset at some point by changes in the composition of the
labour force. As supply of high skill will at one-point surpass demand, driving both
demand and the college premium down. Figure 3 exemplifies this effect, and as a result
human capital does have a positive effect on inequality. Overall no single one of these
elements can explain the rising inequality alone, only by combining them we get a sense

of the whole picture.

5


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