NBER WORKING PAPER SERIES TECHNOLOGICAL INNOVATION AND LABOR INCOME RISK

We examine the relation between technological progress and the riskiness of labor income. Motivated by a simple model of creative destruction, we draw a distinction between technological innovation advanced by the firm, or its competitors. Using administrative data from the United States, we find that own firm innovation is associated with a modest increase in worker earnings growth, while innovation by competing firms is related to lower future worker earnings. Importantly, these earnings changes are asymmetrically distributed across workers: both gains and losses are concentrated on a subset of workers, which implies that the distribution of worker earnings growth rates becomes more rightor left-skewed following innovation by the firm, or its competitors, respectively. These effects are particularly strong for the highest-paid workers. Our results therefore suggest innovation is associated with a substantial increase in the labor income risk, especially for workers at the top of the earnings distribution. Our simulations reveal that the increased disparity in innovation outcomes across firms in the 1990s can account for a significant part of the recent rise in income inequality. An appendix is available at: https://www.nber. org/data-appendix/w26964/ Leonid Kogan MIT Sloan School of Management 100 Main Street, E62-636 Cambridge, MA 02142 and NBER lkogan@mit.edu Dimitris Papanikolaou Kellogg School of Management Northwestern University 2211 Campus Drive, Office 4319 Evanston, IL 60208 and NBER d-papanikolaou@kellogg.northwestern. edu Lawrence D. W. Schmidt Sloan School of Management Massachusetts Institute of Technology 100 Main Street Cambridge, MA ldws@mit.edu Jae Song Social Security Administration Office of Disability Adjudication and Review 5107 Leesburg Pike, Suite 1400 Falls Church, VA 22041 jae.song@ssa.gov Income inequality in the United States has increased sharply over the last thirty years, reaching levels unprecedented during the post-war era. While the data indicate that firms have likely played a central role in this increase, the exact underlying mechanism remains unclear.1 In this paper, we explore the extent to which differences in the rate at which firms acquire new technologies contribute to both workers’ labor income risk and income inequality. We find that higher rates of innovation are associated with greater labor income risk—especially for workers at the top of the earnings distribution. In addition, we find that the increased disparity in innovation outcomes across firms in the 1990s has likely been an important factor in the rise of income inequality across firms. To guide the empirical work, we start with a simple model of endogenous growth, in which firms are collections of product lines. Firms innovate randomly, at potentially different rates. Production of each good requires a worker/manager. Importantly, these workers’ human capital is partly specific to a particular good/firm combination and incentive considerations imply that workers’ incomes are sensitive to firm profits. Firm innovation can take the form of an improvement in one of its own product lines, or by acquiring the technological lead in a product line owned by another firm. If the firm innovates on its own good, the existing worker either receives a wage increase, or is replaced, depending on whether the improvement takes the form of an improvement in the quality of the product or an improvement in production methods. If the firm loses a product line to its competitors, the worker is displaced. An increase in the rate of innovation by the firm can therefore lead to an increase in both the mean, and the dispersion, in the path of future earnings for the firms’ incumbent workers. While some workers are better off since their specific human capital becomes more productive, others are replaced and experience subsequent income declines. By contrast, increases in the rate of innovation by competing firms are associated with more negatively skewed earnings growth. A subset of employees are displaced and experience large income declines, whereas others are largely unaffected. Innovation is thus linked with an increase in the risk of human capital; highest paid workers face more downside risk because they have the most to lose if their specific human capital is displaced—since their outside option is not proportional to their prior wage. The model is simple, yet it leads to rich and testable predictions about links between innovation and the distribution of worker earnings. First, innovation by the same firm is associated with an increase in the dispersion of worker earnings for incumbent workers. Second, innovation by competing firms leads to more negatively skewed earnings growth. Third, both of these effects are larger in magnitude for higher-paid workers. Fourth, the imputed profit-sharing elasticities— comparing the change in worker earnings to change in profits—is larger in response to competitor innovation. This effect arises because the possibility that even own firm innovation can be associated with displacement of a worker’s specific human capital creates a wedge between expected firm and worker-level outcomes that is not present for competitor innovation. See, for instance Song, Price, Guvenen, Bloom, and Von Wachter (2019); Barth, Bryson, Davis, and Freeman (2016).