This Selected Issues paper analyzes the condition of household, corporate, and bank balance sheets; sustainability of the U.S. external current account deficit; the impact of a slowdown in the growth on the euro area economy; and the implications of the reduction in U.S. treasury securities for monetary policy and financial markets. The study discusses the pros and cons of investing government assets in private securities; the recent changes in agricultural support policy and their impact on other countries; technological innovations and the adoption of new technologies.

Abstract

This Selected Issues paper analyzes the condition of household, corporate, and bank balance sheets; sustainability of the U.S. external current account deficit; the impact of a slowdown in the growth on the euro area economy; and the implications of the reduction in U.S. treasury securities for monetary policy and financial markets. The study discusses the pros and cons of investing government assets in private securities; the recent changes in agricultural support policy and their impact on other countries; technological innovations and the adoption of new technologies.

VII. Returns to Human Capital and Investment in New Technology1

1. The sharp acceleration in output and labor-productivity growth in the latter half of the 1990s has been attributed to a surge in technological innovations and the adoption of new technologies across the economy. The fact that the U.S. economy has been a leading innovator and has adopted many of the technological changes that took place more rapidly than other major industrial countries has been credited in part to the high degree of flexibility in U.S. product and labor markets. The flexibility in the U.S. labor market, in particular, has been singled out as a potentially important factor since it has allowed firms to more easily reorganize work processes to take full advantage of the productivity-enhancing features of the new technologies.

2. However, there is another avenue through which labor market flexibility has contributed to the strong U.S. productivity performance. This flexibility has allowed a substantial differential between the wages of skilled and nonskilled workers (referred to here as the wage premium) to develop. With the change in technology having a significant skill bias, the demand for skilled workers has increased, bidding up the wage premium, and in turn, the amount of skilled workers has increased and further stimulated investment in new technologies. The link between the wage premium, the acquisition of skills (investment in human capital), and investment in equipment and software embodying new technologies (physical capital) can be illustrated in a simple theoretical model of an economy. Allowing explicitly in the model for the existence of skill-biased technology change and for a positive feedback loop between investment in human capital and productivity growth the model can be used to illustrate the negative effects of policies that serve to limit the wage premium (and returns to human capital) and how these effects may be partially offset by measures to subsidize education

3. In the 1990s, the United States experienced a substantial increase in the wage premium and rising employment of skilled workers in both absolute and relative terms. The increase in the wage premium was reflected in a significant widening in the income distribution (pre-tax basis) in the United States. Other major industrial countries (with the exception of the United Kingdom) did not experience similar widening in their income distributions, suggesting that these countries did not see a substantial increase in their wage premia and in human capital investment, contributing to the slower pace of adoption of new technologies in most of these countries. The more limited differentiation in wages in these countries is related to economic policies and/or institutional arrangements affecting labor market behavior; such practices to some extent may reflect social choices and cultural differences.

A. Theoretical Model

4. A theoretical model can be used to illustrate the dynamic interplay between technological progress, the wage premium, and investment in human capital.2 In the model, individual workers face a choice between supplying unskilled labor or investing in education in order to supply skilled labor at a higher wage. Skilled labor commands a higher wage because of its higher marginal productivity. The choice of whether to acquire skills is dependent on the cost of education and the wage premium for skilled labor; a fall (rise) in education costs will increase (decrease) investment in human capital and an increase (decrease) in the wage premium will raise (reduce) human capital investment. With the assumption that technological change tends to be (at least in its initial phases) skill-biased such that higher-skilled labor becomes more productive relative to lesser-skilled labor, the model can illustrate a positive link between investment in human capital and technological progress. An improvement in technology increases the demand for skilled labor, leading to a rise in the wage premium and stimulating investment in human capital. Positive spillover effects arise as a growing pool of skilled workers fosters conditions conducive to the diffusion of technology across the sectors of the economy and spurring further innovation.3

5. The model also can illustrate the impact of policies or institutional arrangements (such as centralized “cooperative” wage bargaining) that serve to limit the differential in wages across groups of worker with different skill levels. For example, the skill premium can be reduced by the introduction of an income tax (especially one with very progressive marginal rates). Such a policy would basically be equivalent to a negative shock to the relative productivity of skilled versus unskilled workers. It would reduce incentives to acquire education by lowering the after-tax/transfer wage premium. Income disparity between skilled and unskilled labor would be reduced, but at the cost of lower economic output growth.

6. The effect of policies or institutional arrangements that effectively cap the wage premium can be offset to some extent by subsidies that reduce the cost of education. Such subsidies would encourage skill acquisition; however, this would be accomplished in a less efficient manner than if there were sufficient flexibility in the wage premium. While education costs are an important element in determining investment in human capital, they tend to be small in relation to the opportunity cost of foregone wages during the period during which skills are acquired. Nevertheless, some subsidization of education costs is a key feature of the education system in all countries in recognition of the potentially great social benefit from skills acquisition.

B. Experience in the United States

7. In the last 60 years, the wage premium in the United States between college-educated (used here as a proxy for “skilled” workers) and high-school graduates (an “unskilled” proxy) has shifted dramatically. In the 1940s, the premium fell significantly, before recovering in the 1950s and 1960s. The premium narrowed again in the 1970s, but it subsequently has risen sharply, increasing to an unprecedented level in the late 1990s (Figure 1). For heads of households, the premium has doubled in the last two decades, while for the work force as a whole it has increased by more than 50 percent (Figure 2). At the same time, the supply of skilled workers has increased both absolutely and in relation to unskilled workers (Figure 3). This joint increase in the skill premium and the relative supply of skilled workers can be traced back to the very strong relative demand for skilled workers during the 1990s.4

Figure 1.
Figure 1.

United States: Skill Premia1

(1999 dollars)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: U.S. Census Bureau. Current Population Survey.1/ Wage differential between college and high school graduates.
Figure 2.
Figure 2.

United States: Average Wages by Skill Level

(1999 dollars)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: U.S. Census Bureau. Current Population Survey.
Figure 3.
Figure 3.

United States: Employment by Skill Level

(Thousands of people)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: U.S. Census Bureau. Current Population Survey.

8. This rise in the skill premium has coincided with a rapid acceleration in technological progress. Expenditures on new information technology equipment and software in the United States have increased sharply during the period (Figure 4). In turn, the increases in investment in new technologies, in employment of skilled workers, and in the wage premium have been accompanied by sustained rapid growth in the United States and strong labor productivity growth (Figure 5).

Figure 4.
Figure 4.

United States: Investment in Information Technology Equipment and Software

(Percent of nonresidential fixed investment)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: U.S. Department of Commerce, Bureau of Economic Analysis.
Figure 5.
Figure 5.

United States: GDP and Labor-Productivity Growth

(Percent change)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Sources: U.S. Department of Commerce, Bureau of Economic Analysis; and Bureau of Labor Statistics.

C. International Comparisons

9. Data on information technology investment during the 1990s show that, as a share of GDP, such investment rose sharply in the 1990s in the United States, the United Kingdom, and Canada, while it remained broadly unchanged in France and Germany (Figure 6). The United States also led all of the major industrial countries in spending on research and development (Figure 7). Machin and Van Reenen (1998) demonstrate that skill-biased technological change and research and development intensity were associated with increased demand for skilled labor. They find that these factors are especially important in explaining the significant increases in the demand for skilled labor during the 1990s in the United States and the United Kingdom 5

Figure 6.
Figure 6.

International Comparison: Information Technology Investment

(Percent of GDP)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: WITSA/IDC.
Figure 7.
Figure 7.

International Comparison: Private Business Expenditure on Research and Development

(Percent of GDP)

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: OECD.

10. A substantial widening of the income distribution in the United States during the 1990s can be linked to the rise in the wage premium. In contrast, with the exception of the United Kingdom, income distribution was largely unchanged in other major countries, whether measured in terms of the ratio of incomes of the top to the bottom 20 percent of the population or the Gini coefficient (Figure 8). Time-series data on the wage premia in these countries comparable to that in the United States is not available; however, movements in the wage premium can be inferred from changes in the income distribution. A widening in the income distribution would be expected to be, at least in part, associated with an increase in the wage premium, as illustrated by the behavior of the income distribution and the wage premium in the United States Hence given little change in income distribution there is reason to suspect that wage premia in other countries have not increased substantially. This situation might reflect economic policies or institutional arrangements that have limited the rise in the relative wages of skilled worker, and in a time of significant skill-biased technological change, investment in human capital has been hindered, adversely impacting on the pace of adoption of new technologies

Figure 8.
Figure 8.

International Comparison: Income Distribution1

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

Source: Luxembourg Income Study (LIS Database).1/ Based on pre-tax income.2/Ratio of the highest 20th percenule to the 20th lowest percentile.

11. Education subsidies can have an important effect on net returns to skill acquisition. Data on total government spending for higher education shows that all of the major countries spend broadly comparable amounts, with the exception of Canada which spends significantly more than the others (Figure 9). Thus, although Canada has not experienced a comparable widening of income distribution as the United States, its higher level of education spending may explain in part its more favorable performance in skill acquisition and adoption of new technologies in relation to most of the other major countries.

Figure 9.
Figure 9.

International Comparison: Total Government Expenditure for Higher Education

Citation: IMF Staff Country Reports 2001, 149; 10.5089/9781451839586.002.A007

1/ Includes all spending for education beyond the secondary level.

List of References

  • Acemoglu, D., 1998, “Why Do New Technologies Complement Skills? Directed Technical Change and Wage Inequality,Quarterly Journal of Economics, Vol. 113 No. 4, November.

    • Search Google Scholar
    • Export Citation
  • Autor, D., L. Katz, and A. Krueger, 1998, “Computing Inequality: Have Computers Changed the Labor Market?Quarterly Journal of Economics, November.

    • Search Google Scholar
    • Export Citation
  • Berman, E., J. Bound and S. Machin, 1998, “Implications of Skill-Biased Technological Change: International Evidence,Quarterly Journal of Economics, Vol. 113 No. 4, November.

    • Search Google Scholar
    • Export Citation
  • Blankenau, W., 1999, “A Welfare Analysis of Policy Responses to the Skilled Wage Premium,Review of Economic Dynamics, Vol. 2, 209849.

    • Search Google Scholar
    • Export Citation
  • Bound, J. and G. Johnson, 1992, “Changes in the Structure of Wages in the 1980s: An Evaluation of Alternative Explanations,American Economic Review, Vol. 83 No 3, June.

    • Search Google Scholar
    • Export Citation
  • Devroye, D. and R. Freeman, 2001, “Does Inequality in Skills Explain Inequality of Earnings across Advanced Countries?,NBER Working Paper 8140, February.

    • Search Google Scholar
    • Export Citation
  • DiNardo, J., N. Fortin and T. Lemieux, 1996, “Labor Market Institutions and the Distribution of Wages, 1973-1992: A Semi-parametric Approach,Econometrica, Vol. 64, No. 5, 10011044.

    • Search Google Scholar
    • Export Citation
  • Galor, O. and O. Moav, 2000, “Ability-Biased Technological Transition, Wage Inequality and Economic Growth,Quarterly Journal of Economics, Vol. 115 No. 2, May.

    • Search Google Scholar
    • Export Citation
  • Goldin, C. and L. Katz, 1999, “The Returns to Skill across the Twentieth Century United States,Mimeo, Harvard University.

  • Gottschalk, P. and T. Smeeding, 1997, “Cross-National Comparisons of Earnings and Income Inequality,Journal of Economic Literature, Vol. XXXV, pp. 633687.

    • Search Google Scholar
    • Export Citation
  • Gust, C. and J. Marquez, 2000, “Productivity Development Abroad,Federal Reserve Board Bulletin, October.

  • Haskel, J. and M. Slaughter, 1998, “Does The Sector Bias of Skill-Biased Technical Change Explain Changing Wage Inequality?NBER Working Paper 6565, May.

    • Search Google Scholar
    • Export Citation
  • Katz, L. and K. M. Murphy, 1992, “Changes in Relative Wages, 1963-1987: Supply and Demand Factors,Quarterly Journal of Economics, Vol. 107 No. 1, February.

    • Search Google Scholar
    • Export Citation
  • Katz, L., 1999, “Technological Change, Computerization, and the Wage Structure,Mimeo, Harvard University.

  • Krusell, P., Ohanian, L., Rios-Rull, J. and G. Violante, 2000, “Capital-Skill Complementarity and Inequality: A Macroeconomic Analysis,Econometrica, Vol. 68, No.5, September.

    • Search Google Scholar
    • Export Citation
  • Machin, S. and J. Van Reenen, 1998, “Technology and Changes in Skill Structure: Evidence from Seven OECD Countries,Quarterly Journal of Economics, Vol. 113 No. 4, November.

    • Search Google Scholar
    • Export Citation
  • Prasad, E. S., 2000, “The Unbearable Stability of the German Wage Structure: Evidence and Interpretation,IMF Working Paper, WP/00/22, February.

    • Search Google Scholar
    • Export Citation
  • Prasad, E. S., 2001, “What’s so Special About this Cyclical Expansion in the U.K.? A New Perspective from Labor Market Data,IMF Working Paper, WP/01/XX, March.

    • Search Google Scholar
    • Export Citation
1

Prepared by Martin Kaufman, Rodolfo Luzio, and Steven Dunaway

2

The model follows the basic framework of Blankenau (1999) and extends it using the approach developed by Galor and Moav (2000) to capture the positive link between investment in human capital and investment in new technologies. The model is described in a forthcoming IMF working paper by Kaufman, Luzio, and Dunaway.

3

Acemoglu (1998) characterizes this positive feedback loop as the result of a high proportion of skilled workers inducing a large demand for skill-biased technologies, which in turn encourages faster upgrading of the productivity of skilled workers.

4

See, for example, Autor, Katz, and Krueger (1998) and Katz (1999). These studies conclude that the prime cause of the rise in the skill premium was a shift in the skill structure of labor demand brought about by skill-biased technological changes.

5

Prasad (2001) also finds evidence of increased relative demand for skilled workers in the United Kingdom during the 1990s.

United States: Selected Issues
Author: International Monetary Fund