Can supply create its own demand? Implications for rising skill differentials

Abstract

In the 1980s several advanced countries saw rising skilled wage differentials at the same time as increases in the supply of skilled labour. Some commentators use the orthodox factor demand model based on a competitive labour market to deduce that there must have been shifts in the relative demand curve towards more educated labour. In this paper we show that use of this argument is, in some situations, vulnerable to two criticisms: 1. (i) It is possible to write down reasonable economic models in which the increase in the relative supply of a group can actually increase its relative wage and employment. 2. (ii) As an empirical matter sample selection bias could be a problem. To illustrate these two points we first present a simple matching model and then some empirical evidence based on the large increase in the relative supply of more educated workers that followed the late 1980s changes in the UK educational system but did not result in falling wage differentials of the more educated