Technical Changes Can Reduce Inequalities

Senior Fellow, RIETI

Widening income inequalities and population aging are problems not only for Japan but also for many countries around the world. I would like to examine the "self-restoring force" of the market economy, a mechanism in which such problems are alleviated by the working of market forces, using a long-term time frame spanning several decades. The starting point is the theory of directed technical change (DTC), which has been advocated by Professor Daron Acemoglu of the Massachusetts Institute of Technology (MIT) since the late 1990s.

Income inequalities in advanced countries began to widen in the 1970s. In Japan, this occurred in the 1980s and developed into a major social problem in the 2000s. According to a 2006 paper by MIT Professor David H. Autor and others, polarization of the labor market (see the Keywords section) has been taking place in the United States. However, this trend may not last forever.

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It is usually assumed that the direction of technological advancement is determined by how things develop in the fields of natural science and engineering, independent of economic and social conditions. What is innovative about the DTC theory is its assumption that the direction of technical change is determined by the conditions of the market economy. Based on this theory, the technology trend may, in due time, change its direction in response to the ongoing market conditions characterized by widening inequalities. In the long run, it is anticipated that the current technology trend will be replaced with one that is in favor of the types of technologies that would reduce inequalities.

The essence of Acemoglu's theory is quite simple. Companies are compelled to conduct research and development (R&D) in a way to maximize profits. Therefore, they strive to develop technologies that would enable them to use abundantly available resources and reduce the use of scarce ones. As a result, technical change will move in a direction that calls for intensive use of abundant resources and less use of scarce ones. This is an example of the direction of technical change shaped by the availability of resources in the market.

For instance, an increase in wage inequalities between college graduates and those without college degrees can be attributed to an increase in the supply of the college graduate workforce. With the popularization of higher education, the number of college graduates increased sharply over a short period of time, making college graduate workforce a relatively low cost. At the same time, however, companies changed the direction of technology development in a way to make greater use of college graduates as they became abundantly available. As a result, demand for college graduate workforce increased and so did their wages, leading to greater wage inequalities with high school graduates and those with lower education.

Long-term changes in income inequalities can be explained by the same theory. The industrial revolution brought on by the invention of the steam engine in the 18th century turned a massive number of workers—those who were unable to catch up with the technological paradigm shift—into unskilled labor. As a result, income inequalities widened in the first half of the 19th century.

But then, from the latter half of the 19th century through the first half of the 20th century, income inequalities narrowed with the proliferation of production technologies for unskilled work. This occurred because companies developed mass production and other technologies that would enable them to take advantage of abundantly available cheap, unskilled workers and save on the use of expensive, skilled ones. As a result, demand for unskilled workers increased, which in turn drove up their wages, leading to the emergence of a middle income class.

What has been discussed above is an idea that can be described as an "inequality cycle." With the advancement of science, revolutionary changes in the technology systems—as seen in informatization—occur once every 50 to 100 years. Each time such major changes occur, income inequalities widen between a small number of winners (high-skilled workforce under the new technology regime) and a vast number of losers (low-skilled human resources) who cannot catch up with the changes. However, the direction of technology innovation will change in due time to reduce inequalities, thus creating a cycle of widening and narrowing of inequalities. As such, inequalities will not continue to widen forever but begin to narrow at some point in the future. Markets have a self-restoring force.

Another theory explaining the widening and narrowing of inequalities is the Kuznets curve (see the Keywords section), which considers it as a one-time phenomenon that occurred in the modernization process from the 18th through the 20th centuries. The inequality cycle concept, in which the phenomenon is assumed to repeat itself, can be considered as the generalization of the Kuznets curve theory.

There are other theoretical models that explain the widening inequalities in times of major technological changes and their subsequent narrowing. For instance, Professor Phillipe Aghion of Harvard University has analyzed how companies and employees adapt to changes in a transition period in which key technologies applied in a wide range of fields are replaced with new ones.

According to his findings, demand for high-skilled workers with high learning ability rises, and inequalities widen in the initial phase of transition where adaptability is what counts. However, as new technologies proliferate, the need for high-skilled workers declines and inequalities narrow. In this theory, a decrease in wage inequalities is caused by the proliferation of new technologies per se. The DTC theory differs in that it focuses on the self-restoring force of markets, i.e., inequalities narrow as a result of a change in the direction of technological advancement.

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What will happen to income inequalities in Japan and the world in the future? Based on these research findings in recent years, the implication of the widening inequalities observed today is that low-skilled workforce is being supplied abundantly and cheaply under the new technology paradigm called informatization.

Prior to informatization, white-collar workers doing routine office work were the middle-skilled workforce. The proliferation of information technologies has turned them into the low-skilled workforce with computers taking over their jobs. Meanwhile, the high-skilled workforce (creative knowledge workers) in the era of informatization becomes more expensive. The situation resembles that of the inequality-widening phase in the 19th century.

Looking to the next several decades in light of the DTC theory, it is expected that technical change will occur in the direction of reducing dependence on high-skilled workers and increasing the use of low-skilled ones. More specifically, it is inferred that technology systems will change in such a way that ordinary people with no outstanding creativity would be able to produce some sort of goods and services by utilizing information technologies. This would increase demand for low-skilled workers, causing a rise in their wages. Thus, in the long run, income inequalities would level off and begin to decrease.

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The DTC theory also provides important implications for technological innovation in the area of population aging. At the ongoing session of the Diet, legislators are moving to finalize the plan to increase the consumption tax rate. However, the proposed reform of the tax system or that of the pension system is to address the problem of population aging merely in fiscal terms. There is no difference in that the era of a "one-on-one society," in which the number of elderly aged 65 and over roughly equals that of the working age population, will become realized around the middle of this century.

The young workforce—those who would be able to provide medical and care services to elderly people—will decrease to one-third of the current level in terms of per elderly person. If elderly care services remain as labor intensive as today, care services will be short in supply and go up in prices. This would result in the deterioration of the quality of life for elderly people even if the current levels of pension benefits are maintained. Even if prices of care services are kept low by means of regulations of the Ministry of Health, Labour and Welfare, the quality of life for the elderly would deteriorate all the same because the supply of care services would decrease and waiting time for services would increase significantly.

However, the DTC theory dictates that companies are bound to change the technological structure of the elderly care service industry in the direction of reducing labor input, a scarce resource, and increasing capital input. Therefore, what Japanese companies should do is to develop technologies that would turn medical and care services into a capital-intensive industry (e.g., wearable robots for care providers, mechanized beds). Such a major shift in technologies would alleviate many of the difficulties associated with aging by improving the quality of life for elderly people and raising wage levels for care providers.

Technology development driven by profit-seeking motives can eventually reduce income inequalities and ease difficulties associated with aging. The market economy is not only capable of achieving equilibrium through price adjustments, but also improving the welfare of people by changing the direction of technological innovation. It may not be fully realized for the current generation, but the self-restoring force of markets will definitely improve society for future generations. There can be a ray of hope for the difficult time ahead.

>> Original text in Japanese

* Translated by RIETI.


  • [Polarization of the labor market]
    This refers to a phenomenon in which the middle-income class is split into the high-income class and the low-income class. It is also accompanied by the widening of income inequalities between the high- and low-income classes. The introduction of computers worked to increase income levels for the high-skilled workforce—such as corporate managers and those engaged in creative work—by enabling them to improve productivity. On the other hand, those with no special skills lost their jobs and ended up with those paying lower wages.
  • [Kuznets curve]
    As a country develops and its per capita output increases, income inequalities widen for a certain period of time but eventually begin to narrow. The Kuznets curve is the graphical representation of this phenomenon. This also represents a theory advocated by the economist Simon Kuznets. According to his theory, as an agricultural society turns into an industrial society in the process of modernization, income inequalities widen initially, but the degree of income inequality decreases subsequently as more people adapt to industrialization and the government implements social security policies.

July 23, 2012 Nihon Keizai Shimbun

August 6, 2012

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