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Macroeconomic Analysis of Technological Change:

Technological Change and Employment

B. Verspagen, 2005The Economics of Technological

ChangeChapter 7

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Introduction

• Direct and indirect effects of technological change on employment

• The direct effect: to reduce the demand for labor• The indirect effect: higher output offsetting the initial loss

of employment• Indirect compensation mechanism (demand side): cost-

saving innovation leading to lower price, may increase demand for the product

• Indirect compensation mechanism (supply side): – Labor saving innovation embodied in machine will lead to

derived demand in the sector producing machinery– Increased profit opportunities leading to extra investment

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Introduction

• Nature of innovation also matters• Labor saving (process) innovation: direct

negative effect• The product innovation: indirect effects of

a labor saving process innovation (positive effect)– Increased demand for the product:

employment will tend to rise– Create a wholly new demand curve

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Introduction

• Demand side versus supply side?• A labor market with flexible wages: neoclassical

school, true unemployment does not exist, all unemployment is voluntary unemployment

• A labor market with sticky wages: Keynessian economics, labor market equilibrium does not adjust instantaneously, an exogenous decrease of demand for labor led to a shortage of demand and hence unemployment

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Introduction

• Differences between country experiences• ‘Jobless growth’• Labor is not a homogenous production factor

(skills are important)• Structural unemployment: skills bias of

technology• New technologies make low-skilled work

obsolete• Workers with low skills not benefit from the

increased productivity of new possibilities that computers bring

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A model of process innovation and employment

• The joint impact of direct and indirect (compensation) effects of process innovation

• Assumptions: two consumption goods, labor only production factor (no compensation effect in the form of increased demand for machinery)

• All compensation for the direct effect of process innovation will have to come from expanded demand for consumption goods– Price elasticities of demand will play an important role

• Homothetic preferences: income distribution has no impact on aggregate demand

• Focus on the demand for labor

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A model of process innovation and employment

• An expression for the proportionate change of the demand for labor in the two sectors as a function of the various elasticities and the growth rates of the labor coefficients (p.149)

• In two-sector setting, process innovation in one sector has a positive influence on overall employment if this sector has a higher price elasticity of demand than the other sector

• The compensation effect due to a lower price• Process innovation, lower labor costs, lower price,

expansion of demand for the good, overall increase in employment

• The cross price elasticities would also play a role in this process

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A model of process innovation and employment

• The elasticities are not exogenously given but depend on the shares of the good in overall demand (GDP)

• A decrease in relative prices due to reduced costs as a result of process innovation– Increase the sectors’ share in national income

• Decrease in the sectors’ price elasticity of demand– Process innovation leads to higher total employment

» But if persists it will lead to a situation in which total employment falls (due to endogeneity of the elasticity)

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A model of product innovation and employment

• Switch to labor supply side of the market• Assumptions: n consumption goods, manufactured using

a single unit of labor, no process innovation • All goods can be produced at the same labor productivity

implying a single price for all goods where all goods have an identical share in total employment and national income

• Expression (p. 151) must always be positive which implies that product innovation will always increase the employment level

• Product innovation increases demand in the goods market, this increased demand must be financed by a higher willingness to take a job (supply side)

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A model of product innovation and employment

• The size of the employment effect of product innovation depends on the rate of substitution between the consumption goods

• The larger substitutability between the consumption goods, the smaller the employment effect

• A new product will not raise demand much, if degree of substitutability between consumer goods is high

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A model of skill-biased innovation and employment

• Structural unemployment• Assumptions: single production factor labor, single

consumption good, skilled and unskilled labor, expression (p. 153-154)

• All rates of innovation positive but that innovation primarily replaces unskilled technical change: demand for skilled labor will increase

• The effect on the demand for unskilled labor is ambiguous

• If the rate of substitution between the two types of labor is high, we may see an increase in the demand for unskilled labor– The relatively high increase in productivity of unskilled labor will

make it attractive to substitute skilled labor with unskilled labor

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A model of skill-biased innovation and employment

• If high elasticity of substitution: the demand for both types of labor will increase at unequal rates

• The worse-case: the demand for low skilled labor will decline

• Wage flexibility affecting structural unemployment• If wages are sticky, skill biased technical change may

cause structural unemployment (low skilled workers losing their job)

• If wages are flexible, the result will be lower real wage growth relative to skilled workers

• Skill-biased technological change with innovation mainly replacing unskilled labor

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Innovation and employment: ICTs revolution

• Three models with simplifying assumption: constant rate of substitution between products or production factors, homothetic preferences

• Real world with various indirect effects of innovations

• Freeman and Soete: employment growth in the OECD area over the period 1970-2000

• Positive employment growth• Influencing factors: technology (diffusion of

computers and related equipment-ICT) and business cycles

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Innovation and employment: ICTs revolution

• Expectations in ICTs-producing sectors: an increase of demand due to general rise of ICTs, positive effect of product innovation

• Relatively weak employment growth– Explanation: strong international competition and

trade • Variation over time with respect to employment

growth– Explanation: a sort of product-life cycle taking place

with product innovation being followed by rationalization of production in the form of process innovation

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Innovation and employment: ICTs revolution

Conclusions:• International competitiveness and trade

play a major role in determining the impacts of innovation

• The direct and indirect effects of various forms of technological change on employment are not immediate, but instead unfold over time in the forms of an historical process

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Conclusions

• Important differences between process and product innovation in terms of their impact on employment

• Product innovations are expected to have a positive impact on employment, because they raise the level of demand in the product markets and hence higher employment demand results as a derived effect

• Process innovation at least has the potential effect of replacing labor and hence is expected to have a less positive or even negative effect on employment

• There are however indirect effects of process innovations (in the form of derived demand for equipment embodying process innovation and lower prices and hence increased demand that will result of lower production costs in competitive markets)

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Conclusions

• Long-run analysis of employment trends• International differences exist• Direct and indirect effects of technological

change are not immediate• Innovation and technological change are a

constant source of structural change and adjustment

• The model of structural employment issue and the potential skill-bias of technology