Explaining International Differences in Male Skill wage Differentials by Differences in Demand and Supply of Skill

Abstract

This paper explores the hypothesis that wage differentials between skill groups across countries are consistent with a demand and supply framework. Using micro data from 15 countries we find that about one third of the variation in relative wages between skill groups across countries is explained by differences in net supply of skill groups. The demand and supply framework does an even better job at explaining relative wages of low skilled workers.Wage inequality between skill groups differs substantially across countries. In continental European countries skill wage differentials are typically much smaller than in the US, the UK and Canada. This is especially true at the bottom of the skill distribution. Two explanations have been put forward for these differences. The first explanation attributes these differences to differences in underlying demand and supply factors. According to this view relative wages of low skilled workers in the US are lower than elsewhere as a result of the abundant net supply of low skilled workers in the US (Nickell and Bell, 1996;Nickell and Layard, 1999). A second explanation attributes international differences in wage inequality across skill groups to differences in labour market institutions. According to this view high minimum wages, employment protection and the different role of unions are responsible for the relatively favourable labour market position of low skilled workers in continental European countries Kahn, 1996, 2001;Devroye and Freeman, 2001).The paper by Blau and Kahn (1996) is an important contribution to this discussion because that paper does not only present evidence in favour of the importance of institutions but also provides evidence against the demand and supply explanation. Blau and Kahn apply the demand and supply framework developed by Katz and Murphy (1992) to relate differences in relative net supply of skill groups to relative wage differentials between countries. The demand and supply model predicts that a larger relative net supply of a skill group would affect their relative wage level negatively. Blau and Kahn's empirical findings, however, show the exact opposite; while the net supply of low skilled workers in the US is lower than in other countries, their relative wages are also lower. Blau and Kahn therefore conclude that market forces 'do not appear to be consistent with the observed pattern of relative wages by skill in other countries compared to the United States' (p. 831).

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