Skill‐replacing process innovation and the labour market: Theory and evidence

Abstract

AbstractI study the differential impacts of product innovation and process innovation on the labour market. Using European data from 2000 to 2018, I find that industries with proportionally more firms reporting product innovation than process innovation also tend to exhibit a lower income share of low‐skilled workers. To better understand the mechanism, I develop a dynamic growth model in which firms conduct both types of innovation endogenously. In the model, product innovation introduces new intermediate goods, which tend to require high‐skilled workers to implement. Process innovation simplifies existing production technologies and thereby allows firms to replace high‐skilled workers with low‐skilled ones. I calibrate an extended version of the model to the largest two industries in UK in 2014 and 2018, respectively. I find that product innovation has become less costly but increasingly demanding for skills, and the cost of process innovation has increased on average and become more diverse across firms.