Why labor-augmenting technological progress increases employment and wages?

Question

My textbook says that advances in technology typically raise the marginal product of labor and shift the labor demand curve to the right and calls it labor-augmenting technological advances. The book then claims that this labor-augmenting advancement is responsible for the simultaneous growth in wages and employment.

I am struggling to make sense of this as the way I understand it is that if fewer workers are needed to produce a certain output quantity, then why would someone hire more workers and pay them higher wages when they can hire fewer workers and pay them lower wages (since more applicants will be per one spot)

Thank you for your response.

The book is Principles of economics by Gregory Mankiw, 8th edition pg 367 btw.

Answer 1

I found this excellent Economic Letter from the Federal Reserve Bank of San Francisco that speaks to this observation. It is from Carl R. Walsh (july 16,2004) (https://www.frbsf.org/economic-research/publications/economic-letter/2004/july/the-productivity-and-jobs-connection-the-long-and-the-short-run-of-it/ )

In this letter he notes that, newspaper articles blame strong productivity growth for a “jobless recovery,” as economic output grows yet employment does not.

While it appears that faster productivity growth allows businesses to increase production without increasing employment.

His answer lays in the difference between macroeconoimcs and microeconomics perspective on productivity and between the short-run and long-run effects of changes in productivity.

From a micro perspective, productivity growth and new technological innovations are constantly leading to structural changes in the economy, causing one industry to expand in terms of both production and employment, while other industries contract. However, jobs in other industries also expand.

For example, the manufacturing sector productivity increase but there share of total employment declined while employment and output in areas such as the computer industry have grown rapidly.

These shifts in the economy cause jobs to disappear in some sectors while jobs are created in others.

In the short-run, if demand of products rise this will lead to expanding product. And if labor productivity is unchanged, then typically they need to hire more workers to do this. But, if overall demand in the economy has not expanded, then an increase in labor productivity could lead to a fall in employment in the short run.

In the long run, there is an emphasis that an increase in labor productivity increases potential GDP. It does so directly by allowing more output to be produced with the same level of employment, but it also increases employment because it decreases the cost of labor to firms and promotes the creation of new industries.

The cost of labor is noted as not just wages and benefits but also cost relative to the output the workers are able to produce.

A rise in labor productivity lowers the cost of labor at a given level of wages and benefits. If higher productivity makes labor less costly, firms will find it profitable to expand employment.

Answer 2

The logic you presented is known as technological unemployment. It is true that due to technological improvements, you would need less people to do the same amount of work. But along with technological progress, you would need more highly skilled workers to operate these high-tech machinery.

What Mankiw meant (at least according to me) is that the demand for skilled workers may increase by more than the demand for unskilled workers because of skill-biased technological change. If the technological advances that are being introduced constantly into the labor market are good substitutes for unskilled workers and complement the skills of highly educated workers, this type of technological change would lower the demand for unskilled labor and increase the demand for skilled labor.

This is also being supported by the capital-skill complementarity hypothesis suggesting that subsidies to investments in physical capital (e.g. an investment tax credit) will have a differential impact on different groups of workers. Because an investment tax credit lowers the price of capital to the firm, it increases the demand for capital, reduces the demand for unskilled workers, and increases the demand for skilled workers. But it also suggests that that technological progress - for example, the substantial reduction in the price of computing power in recent decades - can have a substantial impact on income inequality, again because it increases the demand for skilled workers and reduces the demand for unskilled workers.

Both terms, skilled-biased technological change and capital-skill complementarity hypothesis come from the George Borjas "Labour Economics 8th edition" course book. I highly recommend you have a look at it.

It might also be worth noting, that some researchers have argued that skill-biased technological change explains most of the increase in wage inequality in the United States. See for example, John Bound and George Johnson, “Changes in the Structure of Wages in the 1980s: An Evaluation of Alternative Explanations,” American Economic Review 82 (June 1992): 371–392