The Employment and Wage Effects of Oil Price Changes: A Sectoral Analysis


WP/95/37-EA
The Employment and Wage Effects of Oil Price Changes:
A Sectoral Analysis by Michael Keane and Eswar Prasad

This paper uses micro panel data to examine the effects of oil price
changes on employment and real wages in the United States, at the aggregate
and industry levels. The paper also measures differences in the employment
and wage responses to oil price changes for workers differentiated by skill
level. Using a panel data set with detailed worker characteristics enables
the efficient estimation of econometric models that correct for various
sources of aggregation and selectivity bias.

The main finding of the paper is that oil price increases result in
substantial wage declines in virtually all sectors of the economy. However,
the magnitude of these wage declines varies considerably by industry and,
within each industry, by skill level. On average, real wages fall between
3 and 4 percent in the long run following a single standard deviation around
trend increase (approximately 19 percent) in the real price of refined
petroleum products. However, oil price increases also result in an increase
in the relative wage of skilled workers. The use of panel data econometric
techniques to control for unobserved heterogeneity is essential to uncover
this result, which is completely hidden in OLS estimates. The results also
indicate that changes in labor force composition induced by oil price
changes produce substantial bias in estimates of average wage effects based
on aggregate data.

Oil price increases are found to reduce aggregate employment in the
short run and shift industry employment shares in the long run. The
long-run effect of an oil price increase on aggregate employment is
positive, possibly indicating substitution between energy and labor in the
aggregate production function. These results are consistent with the
sectoral shift models of unemployment of Lilien (1982), Hamilton (1988), and
others. An additional prediction of sectoral shift models is that workers
tend to move toward those sectors where the relative productivity of labor
(as reflected in wages) increases following a real shock. A comparison of
estimated changes in industry relative wages and employment shares reveals
little support for this prediction.