Institution-Specific Skill Bias

Having found significant SBTC differences across countries, I ask in this subsec- tion whether differences are related to institutions. Recall that I identify SBTC in terms of the slope of an increase in log relative skill supply on log relative earnings. To test whether slopes vary systematically with institutional measures, I replace country-specific interactions with relative skill supply by interactions between insti- tutional measures and relative skill supply. In particular, I estimate the following specification:

ERit=β0+β1RSSit+β2Instit+β3Instit∗RSSit+θ0Xit+νi+uit (4.5)

Terms are as before. I use three sets of institutional measures.35 This speci- fication decomposes the slope into a common and an institution-specfic component:

∂ERit

∂RSSit

=β1+β3Instit

Because the slope indicates SBTC, this specification effectively decomposes SBTC into a common and an institution-specific component. The previous analysis established that SBTC varies across countries. If SBTC differences are related to institutions, we would expect β3 6= 0, whereas we would expect β3 = 0 if SBTC differences are unrelated to institutions. If, as is suggested by Acemoglu [2003], Pischke [2005], and Fadinger and Mayr [2015], more rigid institutions lead to smaller SBTC, we would expect β3 < 0. That is, more rigid institutions are associated with a shallower slope, or a negative one for sufficiently rigid institutions. Note that, because I control for country-fixed effects, institutions are effectively measured as deviations from country-specific means. The effect of institutional variation is effectively identified by countries with decreasing or increasing institutional rigidity exhibiting smaller or larger SBTC.

Results are shown table 4.4. Columns one to three successively add institu- tional variables. There is only mixed evidence for slope differences being systemat- ically related to country-specific changes in institutions. Including factor variables by themselves does not yield significant effects, although coefficient signs on institu- tional measures suggest that SBTC is shallower for more rigid institutions. When including the full set of institutional measures, the interaction term is significant. The SBTC measure, the marginal effect of an increase in log relative skill supply,

35

I include only the first factor variable, both factor variables, and both factor variables and their interaction.

depends on the level of institutional measures. To see how SBTC varies with in- stitutions when interactions are included, figure 4.2 depicts the marginal effect of an increase in log relative skill supply for the specification in column three, and the corresponding confidence intervals at the ten percent significance level, for different institutional values. To help relating this graph to particular countries covered in the dataset, figure C.1 plots the country-specific mean for the factor variables, and depicts institutional variation as circles around the respective mean, with circle size proportional to the sum of variance for both factors.

Starting from the left, subsequent boxes of figure 4.2 show the marginal effect of an increase in relative skill supply at different values of factor 1 and factor 2. The marginal effect indicates the partial correlation, or the slope, interpreted as SBTC. In this light, the marginal effect is insignificant for low values of factors 1 and 2. For low values of factor 1, SBTC becomes stronger, and ultimately significant at the ten percent level, for higher values of factor 2. For given values of factor 2, SBTC becomes weaker for higher values of factor 1, and significantly so for sufficiently high values of factor 1. This provides some evidence for a systematic relationship between measures for distinct features of the institutional environment and SBTC. Recall that factor 1 loads relatively heavily on employment protection, and factor 2 loads relatively heavily on wage bargaining coordination and net replacement rates. Interpreting institutional measures in more substantive terms, this suggests that countries with low levels of employment protection have higher SBTC the higher the level of wage bargaining and net replacement rates. On the other hand, for a given level of wage bargaining and net replacement rates, higher employment protec- tion implies lower SBTC. For example, figure C.1 shows that Australia and Sweden exhibit similar levels of factor 2, measuring intermediate levels of wage bargaining coordination and net replacement rates, but Australia has low and Sweden has high employment protection. Results would suggest that SBTC is higher in Australia than in Sweden. Somewhat counterintuitively, however, results also suggest that countries with both low employment protection and wage bargaining levels and net replacement rates, such as the UK and US, exhibit no SBTC. These latter results may be explained by the limited institutional variation exhibited by countries with low factor values, as shown in figure C.1, making it difficult to identify any effects. Overall, these results provide some tentative evidence that institutional measures may be systematically related to SBTC differences, and thatsomeinstitutional mea- sures are related to lower SBTC. If so, one may ask next whether SBTC differences found before relate to country-specific factors other than the institutional measures included, or whether they can be fully explained by institutional measures. I address

Figure 4.2: Institution-Specific Marginal Effects with Interaction

Marginal effects at the ten percent significance level for specification 4.5, for results shown in column 3 of table 4.4. Marginal effects are shown for selected values of factor variables 1 and 2. Factor variables range from 0 to 5. Factor 1 loads heavily on employment protection, factor 2 loads heavily on wage bargaining coordination and net replacement rates. Higher values indicate more restrictive institutions. Details for factor variables are given in 4.3.1. As argued for in the text, marginal effects indicate SBTC. The figure shows how SBTC varies across countries with institutional measures.

this question in the next analysis.