Trade or Technology: Which is Responsible for UK Wage Inequality?

UK workers in the bottom 10% of the income distribution have seen almost zero real growth in their wages over the last 20 years. In contrast, workers in the top 10% of the income distribution have had real wage increases of around 50%. Two potential causes have been cited for this widening wage gap: international trade and technical change. But which really is to blame? At a lunchtime meeting held in London on 23 June 1999, Jonathan Haskel argued that the contribution of technical change has been exaggerated, and that the evidence suggests that globalisation is a more likely explanation.

The view that trade is the culprit is based on the fact that developing countries are rich in unskilled labour and can supply goods where production is unskilled-intensive at a fraction of developed country costs. Hence, unskilled wages in developed countries must fall if domestic producers are to remain competitive. The technology view argues instead that rapid technical change in recent decades, especially with the widespread introduction of computers, has been skill-biased, raising the relative productivity of skilled workers but reducing demand for unskilled workers and thereby lowering their wage. The main counter-argument to the trade view is that only a small fraction of goods in developed economies are internationally traded. The service sector makes up an increasingly significant part of production and although some services are traded, such as financial services, the bulk are not.

To illustrate why he believed this argument to be flawed, Haskel referred to what he termed 'the greatest labour market survey since Beveridge': the film 'The Full Monty'. At one point in the film, the character Dave takes a job as a security guard in the local supermarket. It may seem reasonable to assume that a security guard’s wages are unaffected by trade. But the film shows why this reasoning is false. Dave is unemployed because the local steel industry has been forced to close because of increased competition from abroad. Such closures create a flow of 'Daves', unskilled workers potentially available as security guards, who drive down security guard wages. So even though supermarket output is non-traded, the wages of people who work there are still affected by trade.

The same reasoning is true for technology. The occupation of security guard is not subject to dramatic technical progress, so are security guard wages unaffected by it? Again, it depends on what is happening to comparable workers in other sectors. If technical progress is moving faster elsewhere, and if it needs more skilled workers, this again creates a flow of 'Daves', reducing security guard wages in the non-traded sector.

This informal argument has an important empirical implication. What matters for wages, Haskel argued, is the potential flow of workers between sectors, so the question is whether the effects of technical change and globalization are felt more in some sectors than in others, that is, it is the differences across sectors that potentially cause wage adjustments. The finding that technical change is occurring within many sectors is not informative about changes in wages: it does not indicate whether technical change is occurring faster in some sectors than in others – i.e. whether there is sector bias. The many studies that find technical change within many sectors are simply uninformative about the effects on wages.

To see the effects of sector bias on wages, consider a fall in the price of T-shirts due to imports from abroad. This would cause a fall in prices in the unskilled-intensive sectors relative to the skilled-intensive sectors. The fall in price in these unskilled-intensive sectors means that such sectors are now unprofitable. These sectors release unskilled workers, who it is now unprofitable to employ, and therefore wages have to change to restore profitability.

Changes in technology work in a similar way. Technical progress in a sector will potentially raise profitability. If technical change occurs in the skill-intensive sector, then skilled wages must rise to restore relative profitability there. If it occurs in the unskilled-intensive sector, then unskilled wages must rise. All technical change matters since any advances might raise sector profitability. This suggests that researchers should look at skilled, unskilled and neutral technical change – i.e. total factor productivity (TFP) – to see if there is an impact on wages. Hence, the impact of sector bias can be summarized: if prices or TFP grow faster in the skill-intensive sectors, then skilled wages tend to rise relative to unskilled wages. But if prices or TFP grow faster in the unskilled-intensive sectors, then skilled wages tend to fall relative to unskilled wages. Thus, the appropriate empirical strategy is to examine whether price or TFP change is more concentrated in the skill- or unskilled-intensive sectors.

According to Haskel's findings for the UK, changes in TFP in the 1980s were not concentrated in skill-intensive sectors. Indeed, TFP changes were more or less uniform across all sectors. Thus, changes in technical progress could not have caused the increase in wage inequality since it would have had to be concentrated in skill-intensive sectors to change relative profitability and hence set off a rise in skilled wages. This finding is robust to using different data sets with different measurements of skill. With regard to the movement in prices, Haskel found that price rises were concentrated in skill-intensive sectors whereas price falls were concentrated in the unskilled-intensive sectors, thus concluding that it was price changes that had led to the rise in wage inequality.

Haskel concluded by stating that these results cast considerable doubt on technology being the major cause of the rise in wage inequality in the 1980s in the UK. The results strongly support the proposition that it was changes in prices. How much such price changes are due to trade is an open question for future work.

DP2091 ‘Trade, Technology and UK Wage Inequality’ by Jonathan Haskel (Queen Mary and Westfield College, London, and CEPR) and Matthew Slaughter (Dartmouth College, Hanover).