Skill-biased technological change and endogenous benefits: the dynamics of unemployment and wage inequality

In this article, we study the effect of skill-biased technological change on unemployment and wage inequality in the presence of a link between social benefits and average income. In this case, an increase in the productivity of skilled workers, and hence their wage, leads to an increase in average income and hence in benefits. The increased fallback income, in turn, makes unskilled workers ask for higher wages. As higher wages are not justified by corresponding productivity increases, unemployment rises. Generally, we show that skill-biased technological change leads to increasing unemployment of the unskilled and to a moderately increasing wage inequality when benefits are endogenous. The model provides a theoretical explanation for diverging dynamics in wage inequality and unemployment under different social benefits regimes. Analysing the social legislation in 14 countries, we find that benefits are linked to the evolution of average income in Continental Europe but not in the US and the UK. Given this institutional difference, our model predicts that skill-biased technological change leads to rising unemployment in Continental Europe and rising wage inequality in the US and the UK.