Market Mechanism and Skill Premiums in the UK 1972-2002

This paper examines the effect of shifts in the relative supply and demand of skills on the skill premiums and wage inequality in the British labour market 1972-2002. We test the Katz and Murphy (1992) hypothesis that the changes of skill premiums can be explained by their relative supply shifts, given stable or steadily growing relative demand. Alternatively, Machin (2001) hypothesis holds if the changes of skill premiums can be explained by relative demand shifts, given stable or steadily growing relative supply. From co-variation of relative skill wages and relative labour supplies of skills, we reject the hypothesis that the relative labour demand for skill is stable over time for either males or females. By using detrended relative skill wages and supplies, we infer that the acceleration of relative demand for skills caused a positive association between relative skill wages and labour supplies for males in the 1980s and the 2000s, and for females after the 1970s. Hence, the steadily growing relative demand in Katz and Murphy (1992) can only broadly fit with the cyclical co-variation of skill premiums and supply for males, but not for the long term increasing trend of skill premiums and supply of females. We find the acceleration of relative demand for skilled workers after the 1970s as suggested in Machin (2001) hypothesis.