Wage inequality, skill inequality, and employment: evidence and policy lessons from PIAAC

Sonja Jovicic

doi:10.1186/s40174-016-0071-4

Abstract

This paper investigates international differences in wage inequality and skills and whether a compressed wage distribution is associated with high unemployment across core OECD countries. Wage dispersion and wage structure are widely debated among policymakers; compressed wage structure is often perceived as an important cause of high unemployment. Firstly, this paper examines differences in wage dispersion across OECD countries and their link to skill dispersion. Some countries that have more compressed (dispersed) wage structures simultaneously have more compressed (dispersed) skill structures as well, and skill differences explain part of the differences in wage dispersion. However, even when accounted for skills, some countries have a more compressed wage structure, most likely caused by labor market institutions. We do not find an effect of wage compression on the labor market performance in the low-skill sector. Based on the Program for International Assessment of Adult Competencies (PIAAC) survey of adult skills for core OECD countries, this paper cannot confirm the skill compression nor wage compression hypotheses. Rather than insisting on the deregulation of labor market institutions and reductions in public welfare policy as the main policy recommendations to achieve higher employment (and higher wage inequality), policymakers should reconsider aggregate demand deficiency and the variation in macroeconomic policies as potential explanations for the employment differences across countries. JEL Classification: J31, J24, E24

Highlights

The variation in wage inequality across developed countries has puzzled economists for many years, and different theoretical explanations and empirical evidence have been presented on this issue
This paper investigates international differences in wage inequality and skills and whether a compressed wage distribution is associated with high unemployment across core OECD countries
Wage dispersion and wage structure are widely debated among policymakers; compressed wage structure is often perceived as an important cause of high unemployment

Summary

Introduction

The variation in wage inequality across developed countries has puzzled economists for many years, and different theoretical explanations and empirical evidence have been presented on this issue. Countries should allow for higher wage dispersion in the bottom half of the wage distribution and lower wages for the low skilled (institutional reform) which should push their employment levels up. This is in line with a trade-off between efficiency and equality (Okun 1975), according to which it is impossible to achieve high employment and low inequality at the same time. Cross-country differences in wage dispersion cannot be explained by cross-country differences in skill dispersion; educational attainment does not seem to be higher in countries where return to schooling is high, and there is wage dispersion within skill levels, which is in stark contrast with marginal productivity theory These arguments are in contrast with theoretical foundations of the wage compression hypothesis. If D9/D5 and D5/D1 are observed, deviations between the data sets are even smaller

Skills and wages across OECD countries

Findings

Conclusions