An Alternative Explanation of Differences in Relative Wages among Developed Economies by Endogenizing Invention, Innovation and Diffusion

Abstract

I develop a model for a small, open, technology-lagging economy that imports leading-edge knowledge from the technology leader by paying high-skilled researchers from the leading country their opportunity cost to train the lagging country's future high-skilled workers while adding to a local appropriate stock of skill-biased knowledge. The laggard may also import only as share of leading-edge knowledge at a reduced licensing fee. I use as the large, technology-leading country the closed economy from an endogenous growth model that endogenizes invention, innovation and diffusion of knowledge that is capable of matching inverse movements of the relative wage and the detrended relative supply of skilled workers plus the various growth experiences of the U.S. over the last 40 years. Innovation is modeled as diffusing skill-biased knowledge (created by what is termed the inventive sector) to adoptive knowledge (accessible by low-skilled intensive sectors), consistent with the diffusion literature. By forgoing a homegrown inventive sector, the technology lagging country has a larger percentage of high-skilled workers in the innovative sector resulting in what I call the specialization in innovation effect. Since the lagging country specializes in innovation, it has more of its resources devoted to innovation which tends to diffuse a larger share of any given amount of imported skill-biased knowledge to adoptive knowledge and thus tends to decrease its relative wage. This effect may help explain the higher wage premium in the U.S. and the U.K. (countries that arguably specialize in inventive rather than innovative activities) than in other developed such as Germany, France, and Italy since the 1980s. Importing a smaller share of leading-edge knowledge contributes to even lower wage inequality in the laggard without sacrificing economic growth because the lower cost of human capital accumulation allows for a faster accumulation rate and more diffusion of knowledge throughout its economy. The specialization effect will be in evidence as long as the effect is not dominated by differential accumulation rates between the leader and laggard economies. If the developed laggard has a threshold level of human capital to access leading-edge technologies, a slower human capital accumulation rate relative to the leader may allow the laggard to import a stock of skill-biased knowledge each period that is much larger that it is capable of producing itself if it did not import technology. This raises the share of total knowledge that is skill-biased and tends to raise the relative wage.