Invention, Innovation, and Wage Inequality for Developed Countries (on Wage Inequality and Growth) Kevin James Bowman, Ph.D. Assistant Professor Bloomsburg University and Sarinda Taengnoi, Ph.D. University of Wisconsin - Oshkosh

A Puzzle Regarding Inequality and Recent Tech. Change U.S. wage and earnings inequality ↑ sharply, Skill-biased Technological Change (SBTC) the main culprit SBTC & information and communication techs. Yet France and Germany: no ↑ in inequality during this time Aghion et al. (1999) surveys the lit. - Even as they had exposure to these techs. Evidence from (Dinardo & Pischke, 1997)…

The standard textbook explanation: Continental Western Europe: SBTC => ↓ L D with labor market rigidities (fixed w L ) => ↑ U L e.g., Mankiw (2000, p. 150) or Frank and Bernanke (2001, pgs ) Yet, U.S. has an unexplained higher return to skills after controlling for i) experience, ii) wage setting institutions, and iii) absolute levels of skills. Blau and Kahn (2005)

Continental Europe as Innovation Secialists & the U.S. as Invention Specialists The Three Forces of Technological Change: The Three Forces of Technological Change: INVENTION: new ideas/techs. with potential to ↑output with given labor. most skill-intensive. INVENTION: new ideas/techs. with potential to ↑output with given labor. most skill-intensive. INNOVATION: early apps of inventions that ↑ output with given labor.moderately skill-intensive. INNOVATION: early apps of inventions that ↑ output with given labor.moderately skill-intensive. DIFFUSION: later apps of innovation across more industries.least skill-intensive but still requires… DIFFUSION: later apps of innovation across more industries.least skill-intensive but still requires… Examples Late 1800s/Late 1900s/ Early 1900s Early 2000s Early 1900s Early 2000s Inventionelectricitycomputer technologies (DOS) Innovationearly plant MS Office software redesigns & & early business apps. electrified equipment redesigns & & early business apps. electrified equipment Diffusionthe spread of More user-friendly & electric tools & sector-specific Office plant designs applications

Novel, theory: Specialization in innovation causes: A greater share of skilled workers innovating rather than inventing (as it licenses invention from abroad). Innovative output modeled as helping to diffuse skill-biased, inventive (frontier) knowledge into more general (adoptive) knowlege. Supported by David (1990), Rogers (1995) Important Facts: - Important info-age techs originated in the U.S. - America’s numerous research universities…

For constant accumulation rates rates at the steady-state: the Direct Effect from Specializing in Innovation: A greater share of high-skilled in innovation => i) smaller ratio of inventive to innovative output => ii) smaller ratio of total to adoptive knowledge (V/A) => iii) smaller relative wage (w H /w L ). iv) a larger percentage of the population that is skilled due to lower inequality (low skilled families can afford higher ed., the cost of which is dependent on the high skilled wage.

From specializing in innovation (in simulations) there are: Two Indirect Effects: 1) The Relative Accumulation Rate Effect: Endogenously The direct effect: ↓ (w H /w L ) => ↑ (P/P*) => ↑ innovative output for given licensed foreign invention => ↑ diffusion of skill-biased, frontier knowledge into skill-saving adoptive knoweldge => ↓ (w H /w L ) and ↑ (P/P*) further. 2) The Partial Licensing Effect: The innovative specialist may choose to license a smaller share of foreign, frontier knoweldge => education is more affordable => ↑ (P/P*) => more skilled workers in innovation: ↑ innovative output relative to licensed foreign invention => ↑ diffusion into adoptive knoweldge => ↓ (w H /w L ) and ↑ (P/P*) further.

The Direct Specialization in Innovation effect And its Two Indirect Effects, 1. the relative accumulation rate effect and 2. the partial licensing effect) all act in the same direction allowing the innovative specialist to have: A lower relative wage (and wage inequality) A larger share of its population to have a relatively high education Where the higher skilled do not access as high frontier knowledge This helps explain for the U.S. (arguably an inventive leader): higher returns to skill, and greater variance in skills for given economic growth rates.

Conclusion: Importing inventions and specializing in innovation can help explain Continental Europe’s: - lower wage inequality - smaller increases in wage inequality during SBTC - lower returns to skill controlling for labor market rigidities, & variance of skills - less variance of skill (accessing stocks of knowledge that are closer in size) - Policy Implication: Allowing foreign Ph.D. grads to stay in the U.S. could decrease (V/A) and w H /w L.

General Abbreviations List L D = low skilled labor demand U L = unemployment rate of the low skilled L = low-skilled labor H = high-skilled labor w = wage rate V= the stock of total knowledge A=the stock of adaptive knowledge (accessible by L and H) (V-A)= frontier knowledge (accessible by H) (V/A) = ratio of total to adaptive knowledge P = human capital investment (think Pupils) g = economic growth rate * = to denote the large economy (which must invent – representing U.S.) no star indicates the innovative specialist (which represents Continental Europe) In paper: W for the Large Economy (instead of *) X for the Innovative Specialist

More Technical Abbreviations (for the formal model) λ = student-teacher ratio f = education fee per pupil x = savings per saver b = borrowing per pupil r = the real interest rate c = consumption per agent θ = marginal propensity to save (MPS) μ = productivity parameter I for the inventive sector N for the innovative sector D for the adaptive sector λ = adaptive knowledge spillover parameter α = the relative importance of skills in innovation. sss = simultaneous steady state