Wage Inequality, Skill Inequality and Employment: Evidence from Piaac

Saturday, 4 July 2015: 8:30 AM-10:00 AM
TW2.1.04 (Tower Two)
Sonja Jovicic, Schumpeter School of Business and Economics, Wuppertal, Germany
This paper investigates how much of inter country difference in wage distribution is related to the difference in skill distribution and whether wage distribution affects employment in OECD countries. The variation in wage inequality across developed countries has been puzzling economists for many years and different empirical evidence has been presented on this issue. According to some economists, the main cause of variation in wage inequalities across different countries can be explained by the fact that some countries with more compressed (dispersed) wage structures simultaneously have more compressed (dispersed) skill structures as well (Nickell and Bell, 1996; Leuven et al, 2000). Anglo-Saxon OECD countries seem to have higher both wage and skill inequalities compared to continental and Nordic Europe. How much of the difference in wage distribution can be explained by differences in skill distribution across OECD countries? Is the skill hypothesis supported by the data? This is the first question this paper is trying to answer.

We first analyze empirically the relationship between wage dispersion (measured by standard deviation and decile ratios) of hourly earnings and skill dispersion (measured by standard deviation and decile ratios) of competency test results. We examine if there is a correlation between the two variables within the countries. Do the countries with more compressed wages also have more compressed skill distribution? How much of the variation in wage distribution can be explained by variation in skill distribution? The effect of skills on wages is estimated by the standard regression model. In the next step we follow a variance decomposition approach in order to estimate how much wage dispersion of one country would change if it had other’s country dispersion of skills (see Freeman and Devroye, 2002). Freeman and Devroye (2002) examined the relationship between skill distribution and earnings distribution based on the four countries in the 90s (Germany, Netherlands, Sweden and US). However, we use a new data set that comprises more countries and more recent time period.

By first examining the relationship between competencies and wages – skill compression and wage compression, we then link this to labor market outcomes in terms of employment and unemployment. Compressed wage structure (usually caused by labor market institutions) is often seen as a cause for unemployment at the bottom end (Siebert, 1997). Due to skill-biased technological change (Katz and Murphy, 1992; Juhn et al 1993), relative demand for high-skill workers increased, whereas relative demand for low-skilled workers declined. In the countries with the flexible wages, wages at the bottom adjusted and employment did not suffer. In countries where wages are compressed, low skilled jobs were cut off. The relevant policy recommendation in order to solve unemployment problem is to allow for dispersed wage structure (higher wage inequality) as this will create employment at the low end. The second question this paper is trying to answer is related to wage inequality and unemployment. Are the jobless people in countries with compressed wage structure workers with low skills? Is there enough evidence for a wage compression hypothesis? Is it true that the countries with high wage dispersion and high wage inequality have higher employment of low-skilled workers, as the theory suggests?

Our analysis is based on OECD PIAAC data set – Programme for the International Assessment of Adult Competencies that was collected in 2011 and 2012. The database comprises the data set on various indicators of skill competencies, earnings, demographic, socio-economics and other information comparable across 14 OECD countries. Countries included in the analysis are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Korea, Netherlands, Norway, Portugal, Spain, Sweden, the United Kingdom and the United States. The adult competency skills are measured by literacy, numeracy and problem-solving in technology-rich environments[1].

[1] Problem-solving has not been done in France, Italy and Spain