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The Hollowing Out of Middle-Skilled Labor Share of Income

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Imagine how a typical factory today operates in many advanced economies. There are no longer many workers lined up along assembly belts. Instead, there are only a few of them—mostly likely engineers—looking at screens of highly sophisticated equipment that does the assembly once done by humans. With technological advancement constantly driving down the cost of capital, firms are increasingly replacing workers with machines.

In the first part of this blog, based on Chapter 3 of the April 2017 World Economic Outlook, we discussed the economic benefits of technological advancement and global integration, and how these forces have impacted labor shares in advanced and emerging economies. In this installment, we discuss more in-depth the phenomenon in advanced economies of the “hollowing out” of the middle-skilled labor income share. This decline is bigger for sectors that are more exposed to automation.

The losing middle

Between 1995 and 2009, the global income share of low- and middle-skilled labor dropped by more than 7 percentage points.

In contrast, the income share of high-skilled labor rose in both advanced and emerging market economies. A benign interpretation would attribute this evolution to the rising skill premium that encourages an upgrading of skills. Over time, therefore, the relative supply of high-skilled labor is greater than that of middle- and low-skilled labor.

Routine no more

Even so, we find that both routine-biased technology and global integration have been at work as well.

To arrive at our results on routine-biased technology, we construct a new cross-country index covering both advanced and emerging economies. The index measures the share of occupations that are at risk of being automated; technological progress is proxied by the evolution of investment goods prices.

We find that countries (and sectors) with high initial exposure to routinization experience relatively larger subsequent declines in labor income shares. This is true of the manufacturing sector in the United States and Italy, for example.

Countries and sectors with low initial exposure to routine tasks, however, see less decline in labor income shares. This is the case for restaurants and hotels in the United States, where human interaction may be less amenable to automation.

Labor pains

Our analysis shows that technology and global integration have primarily affected the income share of middle-skilled labor. The results are consistent with the notion that exposure to routinization and offshoring lower demands for middle-skilled workers, causing them to accept stagnating wages or to be relocated to low-skill and low-pay occupations.

For emerging market economies, the effect of technology on labor income shares is less pronounced. This reflects not only a much lower initial exposure to automation—which has limited the displacement of labor from routine-biased technology—but also a relatively mild decline in the relative price of investment goods.

Dealing with disruption—further thoughts

Technological advancement and global economic integration have been the key drivers behind falling shares of labor income. Yet these are the very same engines of global prosperity. Policymakers need to figure out how to distribute their benefits more evenly.

In advanced economies, policies should focus on helping workers cope with these disruptions. Skill upgrading throughout workers’ careers is one aspect, but so are policies that facilitate the reallocation of displaced workers to new jobs that reduce the cost of job search and transitions.

Safety nets and income support policies could also be considered, though these will need to be tailored to country specific circumstances. Workers losing their jobs to technology instead of trade are likely to be affected more permanently. This will necessitate longer-term redistributive measures to help them cope.

Policymakers in emerging market economies should heed the lessons from the experience in their advanced counterparts. Investment in education and skill deepening will be crucial in preparing their workers to reap the benefits of economic transformation induced by technology and global integration.

The solution lies not in resistance to innovation or retreat from global integration. But rather in embracing them and being prepared for the disruptions—and benefits—that they bring.