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Explaining U.S. Wage Differentials: 1890 to 2005

Written By: Jason Shafrin - Apr• 23•07

America has been characterized as “the best poor man’s country.” In the nineteenth century land was cheap and available and farming provided relatively high living standards. During the twentieth century, however, change has come. By 1920, income equality had risen to all-time highs. Over the next century, income inequality and the returns to skill (i.e.: schooling) have displayed a few broad trends. The chart below explains these trends.

Era Inequality Return to Schooling
1890-1920 Increasing Increasing
1920-early 1950s Decreasing Decreasing
Mid 1950s-mid 1970s Stable Stable
Late 1970s-today Increasing Increasing

A working paper (“The Race…“) by Claudia Goldin and Lawrence Katz seeks to explain these empirical findings using a structural model to estimate both relative labor supply and labor demand. One of the focuses on the paper is the wage premium individuals with higher schooling receive. In the short-run, year-to-year variation in the wage premium is almost entirely explained by the supply of college workers relative to other workers.

In the long-run, the authors find that the college wage premium and high school wage premium roses together between 1890 and 1920, but then “collapsed” between 1915 and 1950. In the period beginning in the late 1970s, the college wage premium began to rise, while the high school wage premium was anemic. There are a few explanations for this. The first is that in the early part of the century, high school graduates were considered skilled workers, workers much more qualified than high school dropouts. In the 21st century, high school graduates and dropouts have much more substitutability between them and only college graduates are now seen as skilled workers.  The authors note that the pace of the increase in the number of college graduates slowed after 1980. Since firms need more and more skilled workers to be able to take advantages of technological advances in their field, the wage premium for college graduates has increased.

Another similar explanation is skill biased technological change (see Berman, Bound and Machin QJE 1998 for more on this topic). Between 1920 and 1950, technological advancements—particularly in manufacturing—decreased the need for skilled labor since a machine took the place of craftsmen. Technological advance in the later part of the 20th century—such as personal computers—required skilled workers in order to be able to maximize the technology’s marginal product. Thus, the wage premium for individuals who could work with technologies such as computers (i.e.: college graduates) increased and wages of those without these skills (i.e.: high school graduates and dropouts) decreased.

Goldin and Katz also look at whether immigration has played a role in the changing wage premium. “[I]mmigration had but a minor impact on the growth in the relative supply of the college educated and a moderate effect on the supply of high school graduate workers relative to dropouts for the 1980 to 2005 period. Consequently immigration played only a modest role in the surge in the skill premium during those years.” Immigration restrictions, such as the National Origins Act of 1924, were also found to have little impact on inequality or skill premia. “In 2005 17 percent of the foreign born population had fewer than nine years of education whereas less than 1 percent of native-born Americans did,” but were also more likely to have a post-graduate degree.  Thus, it is possible that immigration did reduce the wages of individuals on the lowest end of the skill/earnings spectrum.

Goldin and Katz’s conclusion is worth repeating:

“Technological change is the engine of economic growth. Yet, it also has a potentially dark side…technological change creates winners and losers and can sometimes have adverse distributional consequences that may foment social tension. Such distributional problems are more likely when technological change is skill biased, that is when new technologies increase the relative demand for more skilled and more advantaged workers.

A nation’s economy will grow more as technology advances, but the earnings of some may advance considerably more than the earnings of others. If workers have flexible skills and if the educational infrastructure expands sufficiently, then the supply of skills will increase as demand increases for them. Growth and the premium to skill will be balanced and the race between technology and education will not be won by either side and prosperity will be widely shared.”

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