Polarization and Rising Wage Inequality: Comparing the U.S. And Germany

Abstract

Since the late 1970s and continuing through the mid-2000s, overall wage inequality has been increasing in the U.S., Germany, and the UK as well as in other countries. As possible explanations of these trends, most of the literature has focused on skill-biased technological change (SBTC), the supply of skilled workers and changes in institutions such as the decline in unionization and changes in the minimum wage. SBTC has been the most prominent explanation, arguing that the increase in demand for skills is stronger than the simultaneous increase in the supply, leading to an increase in wage inequality. Recent studies have proposed as a nuanced version of SBTC that technological change can have a ”polarizing” effect on the labor market rather than uniformly favoring more skilled groups. That is, technological change can favor highly skilled groups at the expense of less skilled routine-manual and routine-cognitive workers and to the advantage of less skilled (non-routine) manual workers. Starting in the 1990s, there seems to be evidence for polarization in employment in the U.S., Germany, and the UK, while the evidence for polarization of wages is restricted to the U.S.. It has often been argued that for SBTC to be a compelling explanation of labor market trends, the trends have to be similar across different countries having access to the same technology. In light of the polarizing wage trends in the U.S. since the 1990s and considering the strong increase in wage inequality across the entire wage distribution in Germany since the mid-1990s, there are interesting parallels as well as differences between the two countries. These observations motivate our paper, which compares trends in wage inequality in the U.S. and in Germany using a unified framework of analysis based on comparable data. In addition, we account for potential cohort effects, an issue which is mostly ignored by the recent literature on wage inequality, even though SBTC may have a bias in the age/cohort dimension. We examine trends in wage inequality within and across cohorts of full-time working men by describing a set of quantiles. Unconditional wage dispersion in both countries has been rising since the end of the 1970s. However, we find a pattern of wage polarization only in the United States after 1985. In Germany, the 80% quantile increases faster than the 50% quantile which in turn increases faster than the 20% quantile, while in the U.S., the 80% quantile outpaces both the 50% quantile and the 20% quantile. Building upon the approach developed by MaCurdy and Mroz (1995), we separately identify cohort, age, and macroeconomic effects on wage profiles and confirm that between 1979 and 2004, there was, based on conditional time trends, widening wage dispersion in both the U.S. and Germany. This is the case if we consider trends for wages at the median between skill-groups as well as quantile specific time trends within skill-groups. However, there are many distinct patterns across the two countries. For example, for the U.S. we find that time-trends at the median are more positive for high-skilled workers than for lesser skilled workers throughout the entire period – the medium-low-skilled gap ceases to increase during the 1990s. Moreover, time-trends within both the group of low- and medium-skilled workers start polarizing at the end of the 1980s. Trends in Germany are more difficult to interpret. While we find evidence for polarization in Germany across skill-groups regarding conditional wage trends at the median, we find growing inequality within the group of low-skilled and median skilled workers after 1985. Moreover, we see a large role played by cohort effects in Germany – suggesting a role for supply-side effects or an interaction with institutions in Germany – while we find only small cohort effects in the U.S.. In addition to wage trends, we analyze the changes in the skill composition of the workforce and find strong parallel movements between the U.S. and Germany. In both countries, the decline of the share of low-skilled workers stopped in the mid-1990s and the mean age of low-skilled workers fell strongly between the 1980s and the late 1990s. Our results are mixed. On the one hand, there is some similar evidence for wages and, in particular, for employment in the U.S. and Germany which is consistent with a technology driven polarization of labor market. On the other hand, certain patterns in wage inequality across the two economies differ strongly enough so that we believe technology effects alone cannot explain the empirical findings. Episodic changes resulting from changes in institutional factors such as unionization or the minimum wage may explain the differences.

Keywords: Wage Inequality, Polarization, International Comparison, Cohort Study, Quantile Regression

JEL Classification: J30, J31