DP14980 Income-Driven Labor Market Polarization

Author(s): Diego Comin, Ana Danieli, Martí Mestieri
Publication Date: July 2020
Keyword(s): Labor Market Polarization, non-homothetic preferences
JEL(s): E21, E23, J23, J31
Programme Areas: Labour Economics, International Trade and Regional Economics, Economic History, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14980

We propose a mechanism for labor-market polarization based on the nonhomotheticity of demand that we call the income-driven channel. Our mechanism builds on a novel empirical fact: expenditure elasticities and production intensities in low- and high-skill occupations are positively correlated across sectors. Thus, as income grows, demand shifts towards expenditure-elastic sectors, and the relative demand for low- and high-skill occupations increases, causing labor-market polarization. A calibrated general-equilibrium model suggests this mechanism accounts for 90% and 35% of the increase in the wage-bill share of low- and high-skill occupations observed in the US during 1980-2016, and for 64% and 28% of the rise in the employment shares of low- and high-skill occupations. This mechanism is similarly important for the polarization of labor markets in Western Europe during 1980-2016, as well as in the US during earlier decades and, possibly, the near future.