Skill Supply, Technology Diffusion and the Labour Market

Abstract We analyze the short and long-run effects of an increase in the skill supply on skill-specific wages and unemployment in a model with endogenous, nonlinear diffusion of a general purpose technology (GPT) and labour market frictions. We calibrate and simulate the model using the trend rise in relative skill supply in the U.S. over two decades starting in the early 1970s. The transitional dynamics of the model show (i) an initial slump and long-run rise in the relative wage of high-skill labour and (ii) a long-run rise in the relative level of unemployment of low-skill versus high-skill labour. An increase in the number of skilled individuals reduces hiring costs and increases the incentive for firms to engage in the costly adoption of a new GPT. Stronger labour market rigidity and higher worker bargaining power are shown to have similar effects on relative wages and unemployment: changes in relative wages are more pronounced, whereas the response of relative unemployment is muted. The exact opposite effects are found in the case of a higher degree of substitution between products.