Labour quality and aggregate real-wage dynamics

The real wage plays an important role in many aggregate econometrics studies of the labour market. However, average wages, like any other average quantity, can change for two reasons – either through an underlying movement in the earnings potential of a unit of labour of given quality or, alternatively, through compositional changes which alter the relative proportions of different types of labour within the employed labour force. Using data from the General Household Survey to estimate earnings functions, the paper seeks to examine the contribution of these two factors for Britain from 1979 to 1989. It is shown that in periods of rising unemployment compositional changes can have a bigger effect on real-earnings growth than any underlying change in reward to labour of give quality. This raises the question of what economists actually are measuring when considering the behaviour of the aggregate real wage.