The Rise of the Machines: Automation, Horizontal Innovation and Income Inequality

55 Pages Posted: 17 Nov 2014

See all articles by David Hémous

David Hémous

University of Zürich; Centre for Economic Policy Research (CEPR)

Morten Olsen

University of Copenhagen

Multiple version iconThere are 2 versions of this paper

Date Written: November 2014


We construct an endogenous growth model of directed technical change with automation (the introduction of machines which replace low-skill labor and complement high-skill labor) and horizontal innovation (the introduction of new products, which increases demand for both types of labor). Such an economy endogenously follows three phases. First, low-skill wages are low, which induces little automation, such that income inequality and labor's share of GDP are constant. Second, as low-skill wages increase, investment in automation is stimulated, which depresses the future growth rate of low-skill wages (potentially to negative), and reduces the total labor share. Finally, the share of automated products stabilizes and the economy moves toward an asymptotic steady state, where low-skill wages grow but at a lower rate than high-skill wages. This model therefore delivers persistently increasing wage inequality and stagnating real wages for low skill workers for an extended period of time, features of modern labor markets which have been difficult to reconcile with the theoretical literature on economic growth. We further include middle-skill workers, which allows the model to generate a phase of wage polarization after one where labor income inequality increases uniformly. Finally, we show that an endogenous labor supply response in this framework can quantitatively account for the evolution of the skill premium, the skill ratio and the labor share in the US since the 1960s.

Keywords: automation, capital-skill complementarity, directed technical change, factor share, horizontal innovation, Income inequality, wage polarization

JEL Classification: E23, E25, O31, O33, O41

Suggested Citation

Hemous, David and Olsen, Morten, The Rise of the Machines: Automation, Horizontal Innovation and Income Inequality (November 2014). CEPR Discussion Paper No. DP10244, Available at SSRN:

David Hemous (Contact Author)

University of Zürich ( email )


Centre for Economic Policy Research (CEPR)

United Kingdom

Morten Olsen

University of Copenhagen ( email )


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