Working Paper 2010-12 August 2010
Abstract: This paper contributes to a large literature concerned with identifying the source of the widening wage gap between high school and college graduates by providing a comprehensive, multidimensional decomposition of wages across both time and educational status. Data from a multitude of sources are brought to bear on the question of the relative importance of labor market supply and demand factors in the determination of those wage differences. The results confirm the importance of investments in and use of technology, which has been the focus of most of the previous literature, but are also able to show that demand and supply factors played very different roles in the growing wage gaps of the 1980s and 1990s.
JEL classification: J200, J310, J240
Key words: education wage gap, skill wage gap, skill-biased technological change, skill-based wage differentials
I. Introduction and Background
Much attention has been given to the widely documented growth in the gap in earnings between the highly educated and the not-so-highly educated that occurred during the 1980s and 1990s. The implication of this widening gap for income inequality is a concern to some policy makers for moral, economic, and political reasons. Paul Krugman (2002) summed up the potential economic concerns in a New York Times editorial column: "... inequality in the United States has arguably reached levels where it is counterproductive. That is, you can make a case that our society would be richer if its richest members didn't get quite so much." A sample of political warnings about rising inequality is found in Kevin Phillips's book, Wealth and Democracy:
"As the twenty-first century gets underway, the imbalance of wealth and democracy in the United States is unsustainable, at least by traditional yardsticks. Market theology and unelected leadership have been displacing politics and elections. Either democracy must be renewed, with politics brought back to life, or wealth is likely to cement a new and less democratic regime-plutocracy by some other name." (Phillips 2002: 421)
While the debate over whether income inequality serves as an engine of economic growth by providing powerful incentives, or whether it acts as a hindrance to economic potential (or lead to the end of democracy) rages on, it is essential to have a clear picture of the driving forces behind one of the most important culprits: earnings inequality. And since one of the single most important determinants of earnings differences across groups of workers is their education status, the goal of this paper is to provide a comprehensive, multi-dimensional investigation of the evidence as to the source(s) of the widening earnings gap across educational groups.
There is a clear consensus in the economics literature that wage inequality (and more specifically, skills wage inequality) has been increasing. Moreover, there is also agreement that the inequality is most pronounced in the upper portion of the earnings distribution (for example, see Lemieux 2006, Ginther and Rassier 2006, Autor et al. 2006). Research on this topic also agrees on the timing of changes in wage inequality. Most researchers trace the beginning of the increase in the skills wage gap to the mid-1970s (for example, see Piketty and Saez 2003). In addition, much of the literature places the blame for the growing skills wage gap on increasing returns to post-secondary education. Ingram and Neuman (2006), however, argue that years of education is a weak measure of skill in the analysis of wage distribution and that there is a lot more skill heterogeneity among workers. They find that the return to years of education remains constant after controlling for skills. However, given the high degree of correlation between education and skill and the fact that education is typically the mechanism through which one achieves a higher skill level, this paper will focus on educational wage differentials, rather than skill differentials, and will often refer to those with more education as being of higher skill, while those with less education being of lower skill. …