SBTC, SBIT and the supply of human capital, G. Conti and F. Pastore 1 SBTC, SBIT and the supply of human capital 7 th September 2002 by Gabriella Conti † and Francesco Pastore ‡ 0. Introduction............................................................................................................................................ 2 1. Evidence and puzzles ............................................................................................................................. 6 2. Theoretical explanations of wage inequality...................................................................................... 10 2.1. An overview: SBTC & SBIT, LMI & the supply-side .............................................................. 10 2.2. The demand side: a simple model to compare SBTC and SBIT hypotheses .......................... 14 2.3. The supply side: the role of human capital accumulation ........................................................ 19 2.4. The evolution of labour market institutions .............................................................................. 27 3. Testing the SBIT versus the SBTC hypotheses .................................................................................. 29 3.1. Possible testing grounds............................................................................................................... 29 3.2. The within- and between-industry effects .................................................................................. 30 3.3. Summary of the main findings .................................................................................................... 31 3.4. Shortcomings of the BBG’ methodology .................................................................................... 31 4. Policy implications ............................................................................................................................... 36 Concluding remarks ................................................................................................................................ 37 References................................................................................................................................................. 38 ABSTRACT ¥ . This paper aims to survey the theoretical and empirical literature on increasing wage and employment differentials in favour of high skill workers and against low skill workers. Much literature stresses the role of demand shifts against low skill workers, caused by skill biased technical change (SBTC) and by sector biased international trade (SBIT). Moreover, demand shifts with characteristics similar to SBIT are sometimes attributed to changes in the composition of demand for products of different skill intensity. It is shown that while SBTC tends to reduce both the employment and wages of low skill workers, SBIT tends to affect negatively (positively) wages (employment). Demand factors do not seem to be the only factor explaining increasing wage differentials. Bringing supply side factors to the fore actually helps explaining the evolution over time of wage and employment differentials by skill, but leaves unexplained cross country differences, especially those between the high wage dispersion of the US labour markets contrasted with the high EU unemployment level. Different labour market institutions could explain such differences. Much research is on-going on the employment effects of flexible versus rigid labour market institutions. On an empirical ground we show that the now traditional approach of disentangling within and between differences in wage changes is under revision, as it suffers from various shortcomings. Moreover, it ignores the supply side. Panel data analysis and different types of wage equations are the framework to consider contemporaneous demand and supply side factors, without neglecting the role of differences in labour market institutions. JEL Classification: F11, J24, J31, J51, O33 Keywords: Wage Differentials, Skill Bias, Sector Bias, Technical Change, International Trade, Labour Market Institutions, Education policy † Gabriella Conti is student of the Diploma in Economics, University of Essex, and candidate to the Dottorato di ricerca in Development Economics and Policy, University of Naples “Federico II”. ‡ Francesco Pastore is Researcher in Economics, University of Naples II. ¥ Acknowledgements. This paper partly draws on a research work carried out by Conti at the University of Essex. Pastore gratefully acknowledges financial support from the University of Naples «Federico II» awarded by D.R. n. 4385 the 28th December 2000 for a project on: «How Much Technological Unemployment is Due to Technological Change?» and the CNR research grant n. G00D3D3. We thank for comments Gyu-Hee Hwang, Erasmo Papagni. However, the usual disclaimer applies.