Working Paper

Income-Driven Labor-Market Polarization

Abstract: We propose a mechanism for labor-market polarization based on the nonhomotheticity of demand that we call the income-driven channel. Our mechanism builds on a novel empirical fact: expenditure elasticities and production intensities in low- and high-skill occupations are positively correlated across sectors. Thus, as income grows, demand shifts towards expenditure-elastic sectors, and the relative demand for low- and high-skill occupations increases, causing labor-market polarization. A calibrated general-equilibrium model suggests this mechanism accounts for 90% and 35% of the increase in the wage-bill share of low- and high-skill occupations observed in the US during 1980-2016, and for 64% and 28% of the rise in the employment shares of low- and high-skill occupations. This mechanism is similarly important for the polarization of labor markets in Western Europe during 1980-2016, as well as in the US during earlier decades and, possibly, the near future.

Keywords: Labor-market polarization; Nonhomothetic Demand;

JEL Classification: E21; E23; J23; J31;

https://doi.org/10.21033/wp-2020-22

Bibliographic Information

Provider: Federal Reserve Bank of Chicago

Part of Series: Working Paper Series

Publication Date: 2020-10-23

Number: WP-2020-22