The trade-off hypothesis suggests that high wage
inequality in the US and the UK and high unemployment in countries
of continental Europe are the consequence of the same negative
change in the demand for the low-skilled under different degree of
wage rigidity. However, if labor force participation is not
perfectly wage inelastic, then rising wage inequality is likely to be
accompanied by an increase in the inactivity rate. An extended
version of the trade-off hypothesis is therefore proposed here which
states that depending on the institutions that affect wage rigidity,
there is a trade-off between unemployment on one hand and wage
inequality as well as high inactivity on the
other.
This paper uses a labor supply and labor demand model with
heterogenous types of labor in order to test the trade-off hypothesis and to
analyze the effect of market forces and wage rigidity on changes in
the between-group variation in earnings, employment, unemployment,
and inactivity in France, the UK, and the US between 1990 and 2002.
The results provide partial evidence in favor of the trade-off
hypothesis, as well as its extended version. In addition, the
counterfactual simulations based on the estimated model reveal that
exogenous changes in the relative demand for skills dominated in
France, while supply shifts had more impact in the US over the
studied period. In the UK, the opposite effects of the supply and
the demand shifts were of similar magnitude, but the supply effects
dominated for the least and the most educated. |
