Wage Inequality and The Effort Incentive Effects of Technological Progress

This paper introduces technological progress into an efficiency wage model, and argues that changes in the rate of technical change affect not only the demand for but also the effective supply of labour. This creates a new mechanism through which technological progress impacts on the wage of skilled workers relative to that of the unskilled. Previous work has argued that an increase in the relative wage would only come about if there were an acceleration in the rate of skill-biased technological change. In contrast, we find that technical change affects the skill premium even when it is ‘neutral’. Moreover, the paper shows that slower technical change may also increase the relative wage, allowing us to reconcile the change in the skill premium with the productivity slowdown experienced by OECD countries. The main problem of demand-based explanations of the increase in the skill premium is that they cannot account for the simultaneous increase in the unemployment rates for both skilled and unskilled workers. Our framework emphasises the joint determination of wages and employment, and generates wage and employment patterns that are consistent with the evidence.