Employment Inequality: Why Do the Low-Skilled Work Less Now?

Low-skilled prime-age men are less likely to be employed than high-skilled prime-age men, and the differential has increased since the 1970s. This paper investigates why. I build a labor search model encompassing three explanations: (1) factors increasing the value of leisure, such as welfare or recreational gaming/computer technology, reduced the supply of lower skilled workers; (2) automation and trade reduced the demand for lower skilled workers; and (3) factors affecting job search, such as online job posting boards, reduced search frictions for higher skilled workers. I augment the model with heterogeneous workers and occupational choice and calibrate it to match a novel empirical finding: diverging labor market tightness by skill. The empirical finding along with data on wages and worker flows enables me to separately identify effects of all three mechanisms. I find a shift in the demand away from lower skilled workers is the leading cause. A shift in the supply of lower skilled workers cannot explain diverging employment rates and search frictions actually reduced the divergence. In other words, search frictions for higher skilled workers increased, and had that not been the case, employment inequality today would be worse.