Labor markets and earnings inequality: a status report.(Special Issue:
Earnings Inequality)
New England Economic Review (May-June, 1996):11
by Yolanda K. Kodrzycki, Senior Economist, Federal Reserve Bank of
Boston. The author is grateful to Kathy Bradbury, Lynn Browne, and other
symposium participants for helpful discussions, and to Margaret Enis for
research assistance.
COPYRIGHT Federal Reserve Bank of Boston 1996. Reprinted with
permission.
------------------------------------
Earnings inequality has increased dramatically in the United States
over the last decade and a half. Take, for example, average weekly
earnings for adults who work full-time (Figure 1 not here yet). The U.S.
Department of Labor (1994) has calculated that in 1979, a man at the 90th
percentile of the wage distribution earned 3.2 times as much as a man at
the 10th percentile. In 1992, a man at the 90th percentile earned 4.1
times as much. For women, the disparity increased from 3.1 to 3.7 over
this same time period. Men at the bottom of the earnings distribution fell
behind not only in relative but also in absolute terms, as average
earnings for all full-time male earners fell by about 3 percent from 1979
to 1992. For women, average earnings increased by about 15 percent, so the
rise in inequality was less likely to be associated with declining real
earnings. While these particular calculations focus on only two points in
the income distribution, the conclusion that inequality has risen markedly
over the past decade and a half is supported by a large body of
evidence.(1)
Earnings inequality has risen along various dimensions. Highly
educated workers have gained relative to less educated workers.
Experienced workers have earned increasingly more than inexperienced
workers. And pay for similarly educated workers with similar length of
experience has become more unequal. The only significant contrary trend is
that the earnings of women have become more similar to those of men.(2)
Recent evidence also shows that the increase in inequality during the
1980s was greater in the United States than abroad, and that the
distribution of earnings here is much more dispersed than in other
industrialized countries.
Much of the literature on earnings inequality was reviewed in a
landmark survey by Frank Levy and Richard Murnane (1992). The current
paper provides an overview of our present knowledge, concentrating for the
most part on contributions since the publication of the Levy-Murnane
study. It summarizes explanations for trends in inequality by educational
attainment, by experience, within education-experience categories, and in
general. A remarkably diverse array of economic factors (rather than a
single dominant force) have caused the rise in earnings inequality in the
United States. And although the rising education wage premium has received
considerably more attention than the other aspects of inequality, new
evidence suggests that growing inequality is traceable at least as much to
other aspects of work skills.
This survey briefly examines the significance of two refinements to
the measure of earnings - the role of unemployment and underemployment on
the one hand, and the role of earnings variability on the other.
Individuals with a low earnings capacity are increasingly likely to be out
of work or working fewer hours, relative to those with a high earnings
capacity. Therefore the trend toward greater earnings inequality looks
more pronounced when one takes account of persons who work less than full-
time or less than year-round.
The paper assesses how additional social and political influences
have interacted with labor markets in determining inequality. Changes in
taxes and transfers have served to aggravate earnings disparities in the
United States over the last decade and a half, as has the increased
prevalence of single-parent families. The paper concludes with some
observations on past and future research themes.
Changing Returns to Education
The earnings of college graduates and non-college graduates diverged
sharply in the 1980s and early 1990s, after showing little relative change
during the 1970s (Figure 2 not here yet). According to the U.S. Department
of Labor (1994), between 1979 and 1992, real earnings of full-time
year-round male workers rose 5.2 percent for those with a college degree,
while falling for those with less education. In 1992, male college
graduates earned 74 percent more than high school graduates and 133
percent more than high school dropouts. In 1979, these differentials had
been only 37 and 70 percent, respectively. The premium paid for education
also rose for women during the 1980s and early 1990s, although all
categories of full-time women workers except high school dropouts
experienced at least some increase in real earnings. As noted in Levy and
Murnane (1992), these trends have been explained by a combination of
ongoing increases in demand for college-educated workers and shifting
rates of growth of different groups in the labor force.
The Supply of Highly Educated Workers
In the United States, the supply of college-educated workers slowed
in the 1980s as compared to the 1970s, thereby helping to boost the return
to higher education. This swing in the rate of increase in the number of
college graduates was largely the result of demographic influences, as
most of the baby boom generation came of age in the 1970s. Immigration
patterns also played a role in changing the educational composition of the
work force. Borjas (1995) reports that in 1990, nearly a quarter of high
school dropouts in the United States were foreign-born, compared to only
about one-eighth in 1980.(3)
Variation in the supply of labor also has been helpful in explaining
international differences in the relative earnings of college graduates
and non-college graduates. For example, slower increases in the supply of
college graduates during the 1980s contributed to higher education-related
earnings differentials in the United Kingdom and Japan (Katz, Loveman, and
Blanchflower 1995). On the other hand, a greater expansion in the supply
of college graduates in Canada helps to explain a more modest rise in
educational earnings differentials, as compared with the United States.
An important question looking forward is whether the current large
premium for college-educated workers will prompt higher college
enrollments, thereby diminishing the premium in the future. A recent paper
by Mincer (1994) finds that educational attainment does respond to wages,
and that this response will mitigate the trend toward higher wage premia
for college-educated workers. Mincer concludes, however, that the premium
is not likely to fall from its current level. For one thing, the demand
for college-educated labor is likely to keep rising. Moreover, "lags in
the educational pipeline, growing costs (of education), and perverse
demographics represent delays and impediments to timely supply effects."
Mincer also notes that the recent poor performance of elementary and
secondary school students, as measured by the high proportion with poor
reading and mathematics skills, may represent a bottleneck for the supply
adjustment. John Bishop's paper for this symposium further examines how
demand and supply responses are likely to influence the wage premium for
college-educated workers.
The Demand for Highly Educated Workers
Demand for more highly educated workers has been increasing for many
years. The education of the average American worker increased from about 9
years in 1940 to about 13 years in 1990, while the returns to education
increased (Murphy and Welch 1993c).(4) The Levy-Murnane survey noted that
"there is a consensus on the importance of shifts in relative demand, and
there is no shortage of potential factors to account for the demand
shifts. But to date we have an incomplete picture of the relative
importance of these factors." A vigorous debate on this topic continues.
Several hypotheses have emerged concerning demand shifts. The first
explanation is that the mix of jobs has changed because industries such as
manufacturing are a less important part of the economy than they once
were, while service-producing sectors have increased in importance. Recent
studies appear to be in agreement that the growing inequality between
highly educated workers and others is due in part to a changing industrial
structure. However, they also indicate that growing inequality is a
phenomenon common to many industries, and therefore industrial mix cannot
be the dominant factor in explaining trends in inequality.
A second explanation is that international trade has caused the wages
of less educated workers to fall, as the United States competes with
countries where wages are much lower. Although some studies have found
evidence indicating that international competition is an important
explanation for growing inequality, the literature on the effects of trade
is particularly contentious.
A third explanation is non-neutral technological change. The argument
is that American industry has invested in technologies that reduce the
demand for low-end workers, while increasing the productivity (and wages)
of high-end workers. This hypothesis finds support in correlations between
the extent of investment in computers and other high-technology equipment
by an industry, on the one hand, and the growth in inequality in its wage
structure on the other. This hypothesis is appealing in that it
potentially can explain earnings trends across a wide spectrum of
industries.
The remainder of this section briefly reviews some of the recent
studies of the shifting demand for highly educated workers. It divides the
literature into studies of industrial mix, international competition, and
technological change; studies dealing with more than one theme also are
noted under these headings.
Industrial mix. Two recent studies decompose the increased demand for
education into "between industry" and "within industry" effects. Murphy
and Welch (1993a) find that only 19 percent of the increased demand for
highly educated workers between 1968 and 1990 was due to the growing
importance of industries such as professional services, finance, and
education that traditionally employ a relatively high proportion of
college graduates and to the shrinkage of industries such as agriculture,
mining, and low- and medium-skilled manufacturing that employ a relatively
low proportion. The remaining 81 percent was due to higher demand for
college-educated workers among industries across the board.
Berman, Bound, and Griliches (1994) perform a similar decomposition
within manufacturing and also attempt to explain the between- and within-
industry shifts. They estimate that less than one-third of the shift in
employment from production (that is, less educated) to nonproduction (more
highly educated) workers during the 1980s can be accounted for by shifting
employment across industries, and that these industrial shifts in turn are
attributable largely to changes in defense-related demand and
international trade. Berman, Bound, and Griliches find that the degree of
shift toward nonproduction workers within industries was correlated with
industry investment in computers and expenditures on research and
development. The authors interpret this latter finding as indicative of
the role of non-neutral technological change in causing rising inequality.
Several studies examine the role of industrial structure for middle-
and lower-earners. Juhn (1994) notes that the 1980s were distinguished
from the previous four decades by the contraction of industries and
occupations that predominantly employ moderately educated males. Declining
opportunities in the middle of the earnings distribution tended to
increase the competition for low-wage jobs. In cross-state regressions,
Juhn finds that the decline in the manufacturing sector had an effect on
inequality precisely because that is where many moderately educated male
workers have traditionally worked.
Acs and Danziger (1993) study men with earnings below a level needed
to keep a family of four out of poverty. They conclude that the change in
industrial structure during the 1980s had little effect on the earnings of
white men in this category. Black men, on the other hand, were adversely
affected by the loss of opportunities in manufacturing and in lower-paid
industries. The shifts in industrial structure more than offset the
benefit of higher educational attainment for black men.
Hutchens (1993) compares paths to success for 18- and 19-year-old men
without a high school diploma in 1966 and 1979. He finds that the nature
of jobs within certain key industries and occupations changed over time.
The earlier cohort could rely on construction and clerical work to provide
incomes that would keep them out of poverty; these types of jobs provided
less attractive earnings for the later cohort.
Looking forward, the industrial mix of jobs is expected to continue
to change. The U.S. Department of Labor projects that service-producing
sectors will account for almost all of the job growth out to the year
2005, as manufacturing and mining jobs continue to disappear and
construction jobs grow only modestly (U.S. Department of Labor 1994).
Whatever the effects of a changing job mix in the past, however, one
recent study suggests that further changes may have only a negligible
effect on earnings inequality. Schweitzer and Dupuy (1995) examine the
distribution of earnings in the goods-producing and service-producing
sectors for full-time workers between 1969 and 1993. They find that the
earnings distributions in these two sectors have been converging since
1980 and are now quite similar.
International competition. Among the studies most forcefully setting
out a substantial role for international trade are Borjas and Ramey
(1994a, 1994b) and Wood (1994). Borjas and Ramey find that U.S. durable
goods manufacturing industries involved in international trade
traditionally have been more highly concentrated and have paid higher
wages (adjusting for observable characteristics of workers) than other
industries. Increased competition from imports since the early 1980s
lowered the rents earned in these industries as well as the wage bill paid
to workers. The decrease in employment opportunities, in turn, has forced
more workers into competitive sectors, which has pushed average wages
down. Borjas and Ramey examine the ratio of earnings of college graduates
to less educated workers, comparing it with a list of potential
explanatory variables. Using cointegration analysis for the period 1963-
88, they show that the only variable that consistently shares the same
long-term trend with the wage inequality series is the durable goods trade
deficit as a percentage of GDP. (The level of research and development
expenditures per worker appears in a graphical comparison to be correlated
with wage inequality, but does not pass muster in a formal statistical
test.)
Wood performs a detailed analysis of the economic effects of North-
South (that is, developed country-developing country) trade. He concludes
that increased trade with developing countries is the main cause of the
relative shift in demand for more "skilled" (that is, educated) labor in
the developed countries. He notes that not only the magnitude of the
effects but also their timing supports the trade hypothesis, and that
cross-country variation indicates that countries with larger increases in
Southern import competition have experienced a decline in the relative
position of unskilled workers.
Wood bases these conclusions on a comparison of the observed demand
for labor in developed countries to what it would have been had developing
countries not become the site of production for an increased share of
manufactured goods consumed in developed countries.(5) He estimates that
the cumulative effect of manufacturing trade patterns through 1990 was to
increase the demand for skilled (educated) labor in the North, relative to
unskilled labor, by 5.5 percent. But two factors omitted from the analysis
could quadruple this estimate, according to Wood. First, manufacturers in
developed countries have reacted to foreign competition by devising
production techniques that use less unskilled labor. Second, trade has
also reduced the demand for unskilled labor in service-producing sectors,
both because they supply intermediate inputs to domestic manufacturers and
because they participate directly in international trade.
....manufacturing are a less important part of the economy than they once
were, while service-producing sectors have increased in importance. Recent
studies appear to be in agreement that the growing inequality between
highly educated workers and others is due in part to a changing industrial
structure. However, they also indicate that growing inequality is a
phenomenon common to many industries, and therefore industrial mix cannot
be the dominant factor in explaining trends in inequality.
A second explanation is that international trade has caused the wages
of less educated workers to fall, as the United States competes with
countries where wages are much lower. Although some studies have found
evidence indicating that international competition is an important
explanation for growing inequality, the literature on the effects of trade
is particularly contentious.
A third explanation is non-neutral technological change. The argument
is that American industry has invested in technologies that reduce the
demand for low-end workers, while increasing the productivity (and wages)
of high-end workers. This hypothesis finds support in correlations between
the extent of investment in computers and other high-technology equipment
by an industry, on the one hand, and the growth in inequality in its wage
structure on the other. This hypothesis is appealing in that it
potentially can explain earnings trends across a wide spectrum of
industries.
The remainder of this section briefly reviews some of the recent
studies of the shifting demand for highly educated workers. It divides the
literature into studies of industrial mix, international competition, and
technological change; studies dealing with more than one theme also are
noted under these headings.
Industrial mix. Two recent studies decompose the increased demand for
education into "between industry" and "within industry" effects. Murphy
and Welch (1993a) find that only 19 percent of the increased demand for
highly educated workers between 1968 and 1990 was due to the growing
importance of industries such as professional services, finance, and
education that traditionally employ a relatively high proportion of
college graduates and to the shrinkage of industries such as agriculture,
mining, and low- and medium-skilled manufacturing that employ a relatively
low proportion. The remaining 81 percent was due to higher demand for
college-educated workers among industries across the board.
Berman, Bound, and Griliches (1994) perform a similar decomposition
within manufacturing and also attempt to explain the between- and within-
industry shifts. They estimate that less than one-third of the shift in
employment from production (that is, less educated) to nonproduction (more
highly educated) workers during the 1980s can be accounted for by shifting
employment across industries, and that these industrial shifts in turn are
attributable largely to changes in defense-related demand and
international trade. Berman, Bound, and Griliches find that the degree of
shift toward nonproduction workers within industries was correlated with
industry investment in computers and expenditures on research and
development. The authors interpret this latter finding as indicative of
the role of non-neutral technological change in causing rising inequality.
Several studies examine the role of industrial structure for middle-
and lower-earners. Juhn (1994) notes that the 1980s were distinguished
from the previous four decades by the contraction of industries and
occupations that predominantly employ moderately educated males. Declining
opportunities in the middle of the earnings distribution tended to
increase the competition for low-wage jobs. In cross-state regressions,
Juhn finds that the decline in the manufacturing sector had an effect on
inequality precisely because that is where many moderately educated male
workers have traditionally worked.
Acs and Danziger (1993) study men with earnings below a level needed
to keep a family of four out of poverty. They conclude that the change in
industrial structure during the 1980s had little effect on the earnings of
white men in this category. Black men, on the other hand, were adversely
affected by the loss of opportunities in manufacturing and in lower-paid
industries. The shifts in industrial structure more than offset the
benefit of higher educational attainment for black men.
Hutchens (1993) compares paths to success for 18- and 19-year-old men
without a high school diploma in 1966 and 1979. He finds that the nature
of jobs within certain key industries and occupations changed over time.
The earlier cohort could rely on construction and clerical work to provide
incomes that would keep them out of poverty; these types of jobs provided
less attractive earnings for the later cohort.
Looking forward, the industrial mix of jobs is expected to continue
to change. The U.S. Department of Labor projects that service-producing
sectors will account for almost all of the job growth out to the year
2005, as manufacturing and mining jobs continue to disappear and
construction jobs grow only modestly (U.S. Department of Labor 1994).
Whatever the effects of a changing job mix in the past, however, one
recent study suggests that further changes may have only a negligible
effect on earnings inequality. Schweitzer and Dupuy (1995) examine the
distribution of earnings in the goods-producing and service-producing
sectors for full-time workers between 1969 and 1993. They find that the
earnings distributions in these two sectors have been converging since
1980 and are now quite similar.
International competition. Among the studies most forcefully setting
out a substantial role for international trade are Borjas and Ramey
(1994a, 1994b) and Wood (1994). Borjas and Ramey find that U.S. durable
goods manufacturing industries involved in international trade
traditionally have been more highly concentrated and have paid higher
wages (adjusting for observable characteristics of workers) than other
industries. Increased competition from imports since the early 1980s
lowered the rents earned in these industries as well as the wage bill paid
to workers. The decrease in employment opportunities, in turn, has forced
more workers into competitive sectors, which has pushed average wages
down. Borjas and Ramey examine the ratio of earnings of college graduates
to less educated workers, comparing it with a list of potential
explanatory variables. Using cointegration analysis for the period 1963-
88, they show that the only variable that consistently shares the same
long-term trend with the wage inequality series is the durable goods trade
deficit as a percentage of GDP. (The level of research and development
expenditures per worker appears in a graphical comparison to be correlated
with wage inequality, but does not pass muster in a formal statistical
test.)
Wood performs a detailed analysis of the economic effects of North-
South (that is, developed country-developing country) trade. He concludes
that increased trade with developing countries is the main cause of the
relative shift in demand for more "skilled" (that is, educated) labor in
the developed countries. He notes that not only the magnitude of the
effects but also their timing supports the trade hypothesis, and that
cross-country variation indicates that countries with larger increases in
Southern import competition have experienced a decline in the relative
position of unskilled workers.
Wood bases these conclusions on a comparison of the observed demand
for labor in developed countries to what it would have been had developing
countries not become the site of production for an increased share of
manufactured goods consumed in developed countries.(5) He estimates that
the cumulative effect of manufacturing trade patterns through 1990 was to
increase the demand for skilled (educated) labor in the North, relative to
unskilled labor, by 5.5 percent. But two factors omitted from the analysis
could quadruple this estimate, according to Wood. First, manufacturers in
developed countries have reacted to foreign competition by devising
production techniques that use less unskilled labor. Second, trade has
also reduced the demand for unskilled labor in service-producing sectors,
both because they supply intermediate inputs to domestic manufacturers and
because they participate directly in international trade.
Other writers acknowledge that international competition has reduced
the demand for manufacturing production workers in the United States, and
that the timing of international trade patterns accords well with the rise
in earnings inequality. (For example, see Sachs and Shatz 1994.) But
generally they hesitate to attribute a major role to international trade
in explaining trends in earnings inequality. The recent literature on this
topic has been summarized in thoughtful (albeit somewhat skeptical)
reviews by Burtless (1995), Fieleke (1994), and Freeman (1995).(6)
One issue is that the manufacturing sector is relatively small,
accounting for less than 20 percent of U.S. employment in recent years.
Only a subset of these jobs have been directly threatened by trade.
Moreover, at least some of the increase in international trade has been
with developed countries with high wages, limiting the extent to which one
would expect U.S. wages to adjust downward.
Second, the theory predicts that trade should change the relative
output prices of low-skill and high-skill manufactured goods. That is, in
the United States, we should expect to see a decline in the relative price
of non-skill-intensive, import-competing goods. (In fact, it is this price
decline that would cause a drop in U.S. wages.) The evidence on this
prediction is mixed. Lawrence and Slaughter (1993) do not find that
relative prices of goods that use production labor relatively intensively
have declined in the United States. (Instead, their study tends to support
the technology hypothesis, as they find that total factor productivity -
their proxy for technology - rose more rapidly in industries that used
nonproduction workers more intensively.) On the other hand, Sachs and
Shatz (1994) use an alternative price series to show support for the trade
theory.
Another issue concerns trends in other industries. The release of
manufacturing production workers to other sectors should not only have
lowered the earnings of other, relatively less educated workers (as it
did), but also caused other sectors to increase their use of such workers.
Instead, they reduced their demand.
Technological change. A third explanation for the rising earnings
premium for college-educated workers is that there has been a general
shift in demand in favor of workers with relatively high intellectual as
opposed to manual ability. The growing use of computers is thought to have
contributed to this phenomenon. To a large degree, the conclusion that
technology matters is the result of observing that the earnings
distribution has widened in a broad range of industries, and that
investment in technology across industries appears correlated with
earnings premia for college graduates.
The Berman, Bound, and Griliches (1994) and Lawrence and Slaughter
(1993) studies mentioned above are examples of recent research supporting
a role for technology. In addition, Brauer and Hickok (1994) examine
average pay changes for workers with different levels of educational
attainment in 46 industries for the period 1979-89. According to Brauer
and Hickok, industry investment in high tech capital such as computers and
communication equipment plus overall capital deepening accounted for 60
percent of the explained variation in pay trends for college graduates
versus high school dropouts. In agreement with the general findings of
Murphy and Welch (1993a) and Berman, Bound, and Griliches (1994), shifts
in the demand for the output of different industries was the next most
important factor, accounting for about 30 percent of the explained
variation. International trade was found to play a lesser role, and
contrary to the usual argument, trade with developed countries appeared to
play as much of a role as trade with developing countries. Brauer (1995)
has extended this mode of analysis to trends across states. This research
also indicates a greater role for technology than for trade in explaining
the growing premium for a college degree, particularly when the
regressions are extended to include the early 1990s.
Employer decisions with respect to training may have exacerbated the
tendency of technology to cause incomes to become less equal over time.
Most of the workers who receive employer-provided training are technical
and managerial workers who have a college degree. Lynch (1994) has
estimated that only 4 percent of young workers without a college degree
receive formal training at their workplace, and this fraction is lower
than in other industrialized countries.
While a growing body of research suggests that technology has caused
an increase in the relative pay for college graduates, some questions
remain. Howell (1993, 1994) finds that the demand for high-end workers
rose before computer usage became widespread in the workplace, and he
concludes that institutional and organizational changes have been more
influential than technology in affecting relative earnings. More
generally, further research is needed on the ramifications of specific
types of technological change, as the studies mentioned thus far mostly
use very general measures of the state of technology. Some further
discussion of preliminary microeconomic investigations is found in a later
section.
concludes that institutional and organizational changes have been more
influential than technology in affecting relative earnings. More
generally, further research is needed on the ramifications of specific
types of technological change, as the studies mentioned thus far mostly
use very general measures of the state of technology. Some further
discussion of preliminary microeconomic investigations is found in a later
section.
Institutional Influences on Relative Earnings by Educational
Attainment
Aside from shifts in labor supply and labor demand, the more
competitive and more conservative social attitudes of the 1980s may have
contributed to inequality. To lend support to this argument, researchers
have pointed to changes in the role of wage-setting institutions that
traditionally have protected the wages of lower-paid (and, typically, less
educated) workers. Recent studies have focused on declines in the real
value of the minimum wage and in unionization. Institutional differences
in how wages are determined may help to explain why inequality has
increased so much in the United States compared to other industrialized
countries, since demand-side explanations apply similarly across
countries.
The U.S. minimum wage remained unchanged in nominal terms throughout
most of the 1980s. Horrigan and Mincy (1993) simulate what would have
happened to earnings inequality had the minimum wage kept pace with
inflation. They find only modest effects for workers with different levels
of education (and slightly more noticeable effects on the earnings
differences between older and younger workers, and on workers in high- and
low-status occupations). They caution, moreover, that the adjustment of
the minimum wage would have had virtually no effect on inequality as
measured by family income, because of the attenuated relationship between
low wages and low family income. That is, some minimum wage earners live
in poor families while others live in well-to-do families.
From 1969 to 1978, the share of the nonagricultural work force
organized in unions in the United States fell from 29 to 25 percent; over
the 1980s, the share plummeted to 16 percent. The drop-off in unionization
was particularly sharp among younger (that is, 25- to 34-year-old) men who
had only a high school education or held blue-collar jobs. Freeman (1993)
examines pay differentials between unionized and non-unionized workers, as
well as pay changes for workers who changed union status during the 1980s.
He concludes that the decline in unionization explains at least 15
percent, and perhaps as much as 40 percent, of the growing disparity
between wages for college-educated and high school-educated workers. In a
similar vein, Card (1992) finds that changes in unionization account for
one-fifth of the increase in the between-quintile variance of adult male
wages between 1973 and 1987. His study controls for education, experience,
and race, as well as considering whether workers joining unions are
similar in "ability" to their nonunionized peers.
DiNardo, Fortin, and Lemieux (1995) consider the influence of both
the minimum wage and unionization, as well as supply and demand factors,
during the 1980s. They generally find that institutions are quite
important for younger workers. For young men (that is, those with less
than 10 years of experience), the minimum wage and unionization in
combination explain 32 percent of the growing disparity in earnings for
college versus high-school graduates - compared to 42 percent for supply
and demand (with the remainder unexplained). For young women, the
institutional factors (mostly the minimum wage) explain 16 percent. For
older men and women, institutions become relatively less important in
explaining education-based wage differences, although for men with at
least 20 years of work experience unions continue to explain 18 percent of
differential earnings trends. DiNardo, Fortin, and Lemieux emphasize that,
whatever the explanatory power of institutions in the aggregate, they are
important for particular subcategories within the earnings distribution.
For example, the lack of indexing of the minimum wage had a sizable impact
on low earners. Moreover, they stress that the effects are greater when
earnings of part-time workers are also considered.
A growing body of research examines institutions from an
international perspective. Most, if not all, advanced countries have been
subject to similar influences in terms of sectoral shifts, globalization,
and technological change. Gottschalk and Joyce (1992), for example,
estimate that a remarkably similar redistribution of employment across
sectors has occurred in a number of industrialized countries. Yet the
mechanisms by which wages get set differ greatly (Freeman and Katz 1994).
In general, wage-setting systems in Continental Europe are far more
centralized than in the United States. Freeman and Katz provide the
following examples: "In Austria and Sweden . . . peak-level union
confederations and employer federations have historically bargained for
national wage settlements that cover much of the work force but allow
local employers and unions to increase wages above the national settlement
through 'wage drift.' In Germany industry or regional collective
bargaining determines basic wages for an area and the Ministry of Labor
often extends those to all workers. In France the minimum wage is
important in determining the overall level of wages, and the French
Ministry of Labor also extends contracts. In Italy the Scala Mobile, a
form of negotiated wage increase designed to compensate for inflation and
which applied effectively to all Italians, increased the pay of low-paid
workers faster than that of high-paid workers throughout the 1980s" (pp.
51-52). Furthermore, the United States - along with the United Kingdom,
the Netherlands, and France - experienced a more precipitous drop in
unionization during the 1980s than other advanced countries.
In light of these institutional patterns, it is not surprising that
the largest overall increases in inequality occurred in the United States
and the United Kingdom. In addition, Freeman and Katz note that the
largest relative decline in the position of low-wage workers occurred in
the United States.
These findings are not without controversy, however. Gottschalk and
Smeeding (1995) offer two criticisms. First, it is hard to quantify the
extent to which wages are set by institutions. Different measures rank
countries somewhat differently, depending on which characteristics of the
wage-setting mechanisms receive greater weight. Second, studies err on the
side of explaining wage trends by institutions because they do not
distinguish between levels and changes. In particular, in a country with
strong but weakening institutions, these institutions could be used to
rationalize either stability or greater dispersion in wages.
Alternative Explanations: Some Further Thoughts
Most analysts now concede that no one factor is responsible for the
rising education wage premium. At a Federal Reserve Bank of New York
conference on this topic, the participants indicated in a vote that they
believed 60 percent of rising inequality among educational attainment
categories has been due to technology, 10 percent to international trade,
and 30 percent to other factors - including immigration, a low minimum
wage, and changes in wage-setting institutions (Federal Reserve Bank of
New York 1995). Indeed, it is striking that so many factors have
apparently combined to stretch out the distribution of earnings.
Furthermore, it is difficult - if not impossible - to determine
exactly how important a single explanation is because the various
explanations are to some extent interlinked. International competition and
technological change have caused some industries to decline and others to
expand in relative importance. Moreover, technological change and union
strength are not entirely exogenous; some investments undoubtedly have
taken place under the threat of international competition, and
international competition may have been responsible for the changing
influence of unions. When different explanations are correlated in an
econometric study, their relative effects may be masked. On the other
hand, a study that examines only one explanation may exaggerate its
influence, to the extent that other relevant (and correlated) factors are
omitted.
Changing Returns to Experience
Along with higher returns to education, recent research has found
evidence of higher returns to work experience. That is, older workers are
being paid relatively more compared to younger workers (Figure 3 not here
yet). The trends vary somewhat between men and women, however, and they
seem not to apply as clearly to the oldest workers. According to the U.S.
Department of Labor (1994), men with less than 20 years of potential
experience in the work force suffered a real decline in average earnings
of close to 7 percent between 1979 and 1992.(7) Men with at least 30 years
of potential experience averaged a decline of less than 3 percent, while
those with 20 to 29 years of potential experience had no decline. Among
women, the earnings of middle-aged workers (that is, women with 10 to 29
years of potential experience) rose by much more than those of younger or
older workers.
As noted above, it appears that institutional stories apply more
strongly to younger workers - that is, their relative wages have fallen as
a result of a reduction in the real value of the minimum wage and in
unionization. But, in contrast to the proliferation of studies on
education, research on the changing returns to experience is not all that
extensive.
One important preliminary question is the degree to which the
observed wage trends for older and younger workers reflect a cohort effect
rather than experience. That is, if the quality of education has fallen
over time (as declining college board scores would tend to indicate),
younger workers would be expected to fall behind, even if the marginal
return to experience remained constant. Juhn, Murphy, and Pierce (1993)
tend to discount this theory, since they find that the rise in the
education premium has been age neutral. Still, this remains an area for
further research. For one thing, to the extent that rapid technological
change has been important in driving wages, older workers might be
expected to be disadvantaged. The rising premium paid to older workers
could conceivably be the net outcome of offsetting cohort and technology
effects.
Changing Returns to Skill and Other Aspects of Earnings Inequality
The distribution of earnings of persons with similar educational
backgrounds and years of experience also has widened. The literature on
inequality has dubbed this the "within-group" trend. Juhn, Murphy, and
Pierce (1993) estimate that within-group inequality has been increasing
since 1970 - well before the rising returns to education and experience.
They also find that within-group inequality is highly significant. Over
the 1964-89 period, 44 percent of the overall rise in inequality as
measured by the difference between incomes at the 90th and 10th
percentiles is due to trends across education and experience groups and 56
percent to trends within groups.
Juhn, Murphy, and Pierce conclude that the trend in within-group
inequality reflects a rising demand for skills that are possessed to
different degrees by different workers, since employment has shifted
toward industries and occupations that employ skilled workers even in the
face of rising relative wages. By contrast, they find little evidence that
the rise in inequality is due to growing diversity in the extent of skills
possessed by different workers. These skills, which presumably are
observable to individual employers, are not yet well understood by
researchers. Nor are the reasons for the increased returns to skill. The
Levy-Murnane (1992) assessment that within-group inequality is the "most
important unresolved puzzle" about earnings trends remains valid, even
though we now know more than we did then.
This section reviews studies that attempt specifically to explain the
rise in within-group inequality, as well as some more general studies of
inequality that do not focus specifically on differences by education and
experience. As in Juhn, Murphy, and Pierce, the term "skill" is used here
to refer to ability that is not measured by years of education and
experience, even though some authors use "skill" either synonymously with
these other aspects of ability (particularly education) or as a catchall
for all aspects of ability (such as when higher wages are taken as
evidence of higher skills). In an attempt to expand our knowledge beyond
the studies reviewed here, Peter Cappelli's paper for this symposium
explores the characteristics of technology or work organization that are
contributing to rising skill requirements for individual employers, and
then examines how these skill requirements are reflected in wages paid.
Richard Freeman's paper examines the extent to which wage-setting
institutions are responsible for greater earnings inequality.
Uneven Impacts of Structural Change
A possible reason for increased within-group inequality is that broad
changes in the mix of industries or occupations inevitably have a more
direct effect on some workers than others. For example, workers who are
laid off during a period of structural change find it difficult to obtain
comparably paid jobs, which would tend to increase differences within a
given group in the work force. Or if the number of "bad jobs" is expanding
rapidly, a growing number of recent college graduates may be working in
positions for which they are overeducated (while others in this education
category are more fortunate in their job search). Tyler, Murnane, and Levy
(1995) address these topics by asking whether growing numbers of college
graduates are taking jobs that pay high school wages. In general, they
dispel this hypothesis. The percentage of college graduates with "high-
school jobs" fell during the 1980s. By exception, however, the authors
estimate that almost 18 percent of college-educated men aged 45 to 54 were
in "high-school jobs" in 1989, up from less than 15 percent in 1979.(8)
Thus business restructuring appears to have contributed to greater
earnings disparities for this group.
Another aspect of the same theme is that structural change is more
pervasive for minority groups or for individuals in certain geographic
locations. Bound and Freeman (1991) examine the rising gap in earnings
between young black and young white men with similar educational
backgrounds from the mid 1970s through the 1980s. The authors find that
different economic forces affected different groups of young blacks. In
addition to declines in the minimum wage, unionization, and manufacturing
jobs, the economic decline in inner cities was found to affect blacks with
a high school degree or less -particularly in the Midwest. College
graduates, however, did not appear to be affected by geographic factors.
By contrast with the Bound-Freeman study, Acs and Danziger (1993) find
that low-earning blacks were harmed by a loss of manufacturing jobs,
regardless of whether they lived in Northern inner cities or in other
locations.(9)
addition to declines in the minimum wage, unionization, and manufacturing
jobs, the economic decline in inner cities was found to affect blacks with
a high school degree or less -particularly in the Midwest. College
graduates, however, did not appear to be affected by geographic factors.
By contrast with the Bound-Freeman study, Acs and Danziger (1993) find
that low-earning blacks were harmed by a loss of manufacturing jobs,
regardless of whether they lived in Northern inner cities or in other
locations.(9)
Technology and Workplace Organization
As indicated above, a frequently mentioned hypothesis about within-
group inequality is that technological change is increasing the demand for
skill. Research by Cappelli (1993) suggests that the relationship between
technology and skills may be quite complicated, however. Cappelli examined
production workers in a variety of industries using a sample of employers
from the late 1970s to the late 1980s. He measured skill requirements
using an evaluation system developed by Hay Associates that attempts to
capture the autonomy and complexity of jobs. The study found mixed results
concerning the role of technology. In manufacturing, individual production
jobs required more skill over time, and the mix shifted toward jobs with
higher skill requirements. If these changes did not systematically favor
production workers with more (or less) education or experience, Cappelli's
findings are consistent with rising within-group inequality.(10)
Cappelli found that so-called upskilling of manufacturing jobs was
not driven primarily by the implementation of specific technologies such
as numerically controlled machines. Rather it seemed to be related to new
management views concerning how jobs should be redesigned, as well as to a
decline in union power that made their implementation possible. For
clerical work, by contrast, changes in skill requirements were related to
the introduction of new office technologies, such as word processors and
personal computers. Technology had idiosyncratic effects on job
requirements, increasing the skill requirements for some and decreasing
them for others.
In another study, Scott, O'Shaughnessy, and Cappelli (1994) find that
insurance companies have been moving to a flatter organizational
hierarchy. Senior-level managerial jobs are becoming more scarce, but
managers' span of control is becoming greater (since a higher fraction of
jobs we at lower levels). As a consequence, the payoff to attaining a
high-level job has increased.
Research by Osterman (1995) indicates that training practices vary
substantially across workplaces. Business establishments that introduce
so-called high performance work organizations, that have more "humanistic"
values, and whose employees have union representation are relatively more
likely to provide training for their workers. While Osterman's research
stops short of examining the link between training and pay over time, it
does indicate that employers do not react uniformly to economywide
influences such as technological change. Future studies of earnings
inequality may profitably continue to examine the diversity in employer
decision-making.
Wage-Setting Institutions
Research on the role of labor market institutions suggests that the
declining roles of centralized bargaining and of the minimum wage have
given employers more freedom to adjust wages in light of the demands of
the workplace. Employers may also have become more inclined in recent
years to vary pay to reflect performance for their nonunionized workers.
Freeman (1993) found that, in addition to boosting the wages of their
members relative to nonunionized workers, unions tend to reduce the
dispersion of earnings within workplaces. Therefore, a decline in
unionization could lead to greater within-group inequality. The evidence
indicates, however, that inequality of earnings rose roughly as rapidly
among union as among nonunion workers between 1978 and 1988. Freeman
indicates that this is the result of diminished power of unions in the
1980s, as evidenced by the breakdown of pattern bargaining and the
frequency of wage concessions.
Examining almost the same time period as Freeman, DiNardo, Fortin,
and Lemieux (1995) concur that unionization is of very limited
significance in explaining rising within-group inequality. But they
attribute 24 percent of the increase in within-group inequality among men,
and 34 percent among women, to the drop in the real minimum wage.
Evidence of a link between changing pay practices for professional
and managerial workers and increased inequality is still unavailable.
Groshen (1993) examines increasing inequality among nonproduction workers,
using a Federal Reserve Bank of Cleveland survey of employers in its
district. She finds that changes in human resource management practices,
such as linking pay more closely to performance, were not helpful in
explaining growing salary differences in the 1980s.
The Relationship between Unemployment, Underemployment, and
Inequality
Virtually all of the studies cited so far are limited to individuals
with positive earnings. Many of them are restricted to full-time workers
or those working a certain number of hours or weeks per year. These
adjustments make sense in order to help isolate the causes of growing
inequality. But if different groups in the population have different
trends with respect to hours worked, these differences could serve to
reinforce or offset inequality based on rates of pay.
The evidence suggests that the secular decline in demand for less-
skilled workers has resulted in a decrease in both their relative rate of
pay and their relative number of hours worked. Topel (1993) finds that the
largest declines in wage rates between 1967 and 1989 have occurred for
groups for which unemployment and nonparticipation in the work force have
increased the most. Furthermore, virtually all of the long-term increase
in joblessness has occurred among low-wage men. Haveman and Buron (1994)
conclude that the decline in hours worked by low earners (which includes
working part-year, part-time, or not at all) plays a large role in the
increase in earnings inequality.(11)
As noted above, it appears that wage-setting institutions in many
European countries effectively put a floor on the income earned by those
with relatively low wages. If such constraints were introduced in the
United States, economic theory suggests that unemployment and
underemployment of low earners would increase even more. Indeed, empirical
work indicates that unemployment is highest in European countries among
low earners. But income inequality is smaller than in the United States
because of social welfare programs (Freeman 1994).
The Issue of Permanent Earnings Inequality
The findings on inequality have been interpreted as showing that the
poor have become relatively poorer over time, while the rich have gotten
richer. But, in fact, the data come from cross sections of workers, rather
than tracking of individuals over time. If everyone's income merely became
more variable over time, then the data would show greater inequality, but
it would not be true that low earners were falling farther behind high
earners.
Gottschalk and Moffitt (1994) use panel data for the 1970s and 1980s
to distinguish trends in mean income from variation around mean income for
individual workers. They find that the permanent and the transitory
components of the variance of earnings each increased by 40 percent.
Therefore the perception of the poor getting poorer and the rich getting
richer is correct - although the change may not be quite as dramatic as
had been thought. As for the transitory component, which heretofore had
not been studied, Gottschalk and Moffitt find that earnings of union
workers and those employed in manufacturing fluctuate less than earnings
of nonunion workers and those in service-producing industries. However,
de-unionization and industrial shifts together explain only 12 percent of
the increase in wage instability from the 1970s to the 1980s. Thus, the
authors conclude that further research is needed on the sources of
transitory income variability.
From Inequality in Earnings to Inequality in Living Standards
Rising inequality in earnings might be viewed as a relatively minor
issue if other factors acted to equalize living standards. But, to the
contrary, research has shown decisively that in the United States
additional influences generally served to reinforce the growing inequality
in earnings. Some of these factors are related to the labor market, while
others relate to social trends and the role of government.
In contrast to six other major industrialized countries (Australia,
Canada, Germany, the Netherlands, Sweden, and the United Kingdom), the
United States had a greater increase in family income inequality than in
earnings inequality during the 1980s (Gottschalk 1993). For example, the
extent of increase in earnings inequality among prime-aged males in the
United States and Canada was about the same, but Canada experienced no
clear trend in family income inequality as the Lorenz curve shifted in for
lower quintiles and out for upper quintiles (Blackburn and Bloom 1993).
One reason for the difference may relate to family structure and
associated changes in family work effort. We have evidence on how these
factors influenced inequality in the United States without a parallel
understanding for other countries. In a comprehensive examination of
disparities in the United States, Bradbury (1996) finds that the number of
workers per family and hours per worker fell for the poorest quintile and
rose for the richest quintile between 1979 and 1993.(12) The United States
experienced an increase in female-headed families and in individuals
living alone during the 1980s, but Blackburn and Bloom report that Canada
did not. Finally, men and women with high earnings in the United States
increasingly have tended to marry someone in a similar, rather than a
lower, earnings bracket (Murphy and Welch 1993b).(13)
The second reason for the particularly sharp increase in family
income inequality in the United States is that decreasing transfer
payments and a change in tax structure reinforced the growing disparities
in earnings. In Canada, by contrast, public assistance and general social
expenditures increased in the 1980s (Blackburn and Bloom 1993; Gramlich,
Kasten, and Sammartino 1993; Gottschalk 1993).
Third, pensions and health insurance in the United States are
provided largely at the discretion of individual employers rather than
being universal. Little (1995) finds that benefit coverage became less
equal in the 1980s.
Finally, looking at the trends of the past several decades in the
United States, the 1980s were unique in the relative gains of the rich
(Karoly 1993). Presumably, this trend relates to growth in income from
capital relative to other sources.
Historically, growth has increased job opportunities for the poor
more than for the rich. Given strong macroeconomic growth during much of
the decade, the 1980s should have been a period of declining poverty in
the United States, all else equal. Instead, the poverty rate rose from
13.6 percent in 1989 to 15.2 percent in 1991. Blank and Card (1993)
attribute this increase in poverty to the fact that rising wage inequality
and other trends more than offset positive macroeconomic developments.
Bradbury (1996) finds that New England, which experienced an economic boom
of unusual proportions in the 1980s, was the only region of the country in
which the average income of the bottom fifth of families rose during the
1980s, thus indicating that sufficiently strong growth is still able to
help the poor.
Conclusions
As studies have increasingly demonstrated the pervasive nature of the
rise in earnings inequality, researchers have become more willing to
acknowledge that many aspects of labor markets have contributed to the
observed trends in the United States. On the supply side, a decrease in
the rate of growth of college graduates and an influx of relatively
uneducated immigrants help to explain higher returns to education. On the
demand side, changes in industrial structure, international trade, and
technology all appear to play a role. In addition, wage-setting
institutions may cause certain workers to be paid more or less than what
the market would indicate. These institutions have changed over time, in
ways that have accentuated inequality. Distinguishing the individual
effects of different influences remains problematic, however, and may vary
with the time period examined and the particular aspect of earnings
inequality under examination.
Even as a consensus appears to be building that the rise in
inequality has been multi-faceted, some puzzles remain. The papers and
discussions at this symposium address such gaps in our knowledge, and
their findings are particularly relevant as discussions of inequality turn
to possible remedies.
One important question is whether the return to education will
continue to increase in the future, given the widespread perception that
the U.S. economy is generating many low-quality jobs. If the wage premium
for college graduates is expected to hold constant or rise further, then
discussions of new policies to augment the supply of educated workers take
on greater urgency than if market forces (such as higher college
enrollments in response to observed higher earnings) cause the wage
premium to decline.
An increasing body of evidence indicates that new workplace
technologies are resulting in higher wages for skilled workers (where the
concept of skills goes beyond what can be measured by years of education
or experience), and that this phenomenon has played an important role in
creating wider wage disparities. Yet relatively little is known about how
technology influences skill requirements and what can be done to raise the
average skill levels of the work force.
Another outstanding puzzle is the extent to which the trend toward
inequality can be reversed through reform of U.S. wage-setting
institutions. The role of unions and the real value of the minimum wage
have been allowed to erode over time. Furthermore, starting in the 1980s
reforms of taxes and transfers have tended to reinforce rather than offset
the impact of labor market contributions to inequality. If the traditional
tools to redistribute income have been neglected in the United States,
what can this country learn from foreign experiences and what new
institutional options are available?
A final issue is the cost of earnings inequality. Thus far, studies
have not specified clearly what consequences inequality has for
macroeconomic performance. Evidence suggests that greater equality in
Europe, as compared with the United States, has come at the expense of
employment growth. On the other hand, concern is mounting that the United
States cannot remain competitive if college-educated workers continue to
command higher and higher pay, and if labor skills demanded at high-
technology workplaces are in short supply.
Footnotes:
1 For a comparison of alternative measures, see, for example, Karoly
(1993).
2 See Blau and Kahn (1994). Bradbury (1996) finds that inequality
rose for men and women combined during the 1980s, despite the growing
similarity in the earnings of men and women who worked full-time and year-
round.
3 Immigration may also help to explain different wage trends in
regions within the United States. Topel (1994) found that those parts of
the country with the greatest increase in wage inequality were those with
the smallest improvements in labor-force quality. In particular, he
indicated that immigration of low-level Asian and Hispanic workers reduced
indicated that immigration of low-level Asian and Hispanic workers reduced
the wages for non-immigrant workers in the West by about 10 percent.
However, Topel measured labor quality according to the distribution of
workers by wage categories, which would take account of other factors in
addition to education levels.
4 Murphy and Welch estimate that increases in the returns to
education in the 1950s, 1960s, and 1980s more than offset decreases in the
1940s and 1970s.
5 Wood starts by examining the skill and labor content of the
imported goods, but then modifies the estimates in light of the fact that
different relative prices in developed countries would lead them to use a
different mix of inputs, and because a higher price for these goods (were
they produced in developed countries) would lead to a reduction in demand
for them.
6. These reviews also cover recent volumes edited by Bhawati and Koster
s (1994) and Bergstrand, Cosimano, Houck, and Sheehan (1994).
7. Potential experience is defined as age minus years of schooling
minus six. The statistics refer to annual earnings of full-time year-round
workers.
8 Note that this finding conflicts with the generally reported
increase in returns to work experience.
9 Several papers in today's symposium address the role of spatial
determinants of inequality within a metropolitan area, with a subset of
these also indicating how employment opportunities vary by location.
10 If the favored workers were more highly educated or more
experienced, the results are consistent with the above-noted cross-group
trends. Cappelli did not specifically address the issue of whether skills
are correlated with education or experience.
11 The authors indicate that some previous studies underestimated the
role of hours worked by choosing a business cycle peak as the starting
date for their analysis.
12 As was true for individuals, earnings per hour fell for the
poorest quintile and rose for the richest quintile of families. Bradbury
(1996) indicates this was the most important factor explaining the trend
in family income inequality.
13 The available studies disagree about the effect of the increased
tendency of wives to participate in the paid labor force. Murphy and Welch
suggest that this trend has led to greater disparities among family
incomes since the wife's income is no longer inversely related to that of
her husband. However, Cancian, Danziger, and Gottschalk (1993) find that
family income inequality in the United States would have increased to an
even greater extent over the past 20 years were it not for the increased
earnings of wives - especially among black families.
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Yolanda K. Kodrzycki Senior Economist, Federal Reserve Bank of
Boston. The author is grateful to Kathy Bradbury, Lynn Browne, and other
symposium participants for helpful discussions, and to Margaret Enis for
research assistance.