The Allocation of Talent, Economic Development and Skill Premia

Three central observations motivate this paper. First, there is little variation in the fraction of unskilled workers between rich and middle income countries. This occurs despite well-known, large differences in output per worker. Among a set of rich countries, unskilled workers 25 and older, defined as those with at most high school education, averaged 82 percent. Meanwhile, for a set of middle income countries, the average fraction is about 87 percent. Second, skill premia, defined as the the ratio of earnings per skilled worker to the earnings per unskilled worker, varies much more across the same set of countries. The skill premium in the poorer countries is about 62.5 percent higher than that in the rich group: it averaged 1.5 across rich countries whereas it averaged 2.4 for the middle income group. Finally, data from the Programme for International Student Assessment (PISA) indicates substantial variation in the measured talent of young individuals across countries. We develop a parsimonious framework that connects these observations. We model the division of the labor force between unskilled and skilled workers, and map this division into observables such as output and skill premia, as well as unobservables such as ‘quality’ of workers across countries. We discipline this framework with a host of aggregate and cross sectional observations, and then use it to investigate the extent to which the first two observations mentioned above can be accounted for by exogenous differences across countries. We also use the model to infer relative differences in Total Factor Productivity across countries, and compare these with standard measures from the one-sector growth model. ∗Cubas: Central Bank of Uruguay. Ravikumar and Ventura: Department of Economics, University of Iowa, USA. Countries considered in the rich group are Australia, Belgium, Canada, Denmark, Finland, France, Germany, Israel, Italy, Netherlands, Norway, Spain, Sweden, United Kingdom and United States. Countries in the middle-income group are Argentina, Bolivia, Brazil, Chile, Czech Republic, Ecuador, Hungary, Mexico, Panama, Peru, Poland, Slovakia, Uruguay and Venezuela.