Importance of Substitutability Between Factors of Production in Explaining a Changing Wage Differential

Abstract

Rising wage differential during the last two decades has become a hot topic of discussion among the academics as well as the politicians and policy makers. One of the popular but debated reasons put forward is skill-biased technological change argument. However, since skill is hard to measure, so is the skill-bias of technological change. Also economists suspect that increasing free trade between countries may have a prominent role to play in this ongoing debate. In this study, a trade model is used to investigate the rising wage differential. The main finding of this paper is that a skill-biased technological change is neither necessary nor sufficient for increasing wage differential in the presence of trade. In other words, even in the presence of a skill-biased technological change we may see a converging wage differential depending on the substitutability between the factors and their distributive shares. To investigate the role of substitutability between the inputs, a translog cost function is used. I use an aggregate dataset on the Indian manufacturing sector for this study. I find complementary relationship between production and non-production workers. Using Hicksian definition of factor bias, I do not find any evidence of a technological change that favors the non-production workers (used as a proxy for skilled workers in many studies). However non-production workers may not always be a good proxy for skilled workers. Also the production process became more capital intensive in the Indian manufacturing industry. Following Griliches' capital-skill complementarity hypothesis, this supports the idea of increasing usage of skill in the production. Thus the evidence of skill-biased technological change is, at best, inconclusive.