Last week I posted on how much inequality has increased in the last 4 decades. The main conclusion then was that demand for skills, recently polarized by computerization, had driven much of the increase in wage inequality. Figure 1 shows that skills are actually rewarded all over the world, so this story is potentially not unique to the US. Cognitive skills are substantially rewarded across all 22 countries, with an average return of 18% for a "unit" (one standard deviation) of skills. The US is at the top of this with a premium of around 28%, implying a difference of around 50-60% between some one standard deviation above and someone one standard deviation below the average. If wages were determined mainly by luck, beauty or family connections, we would expect to see little connection between cognitive ability and wages. The high returns to skills all over the world confirm that this is not the case. And so inequality of income, is most likely highly related to inequality of skills on top of the demand shifts I explored last week.
Figure 1: Wage returns to skill, 2011-2013.
Education attainment has increased substantially in the US during the previous century, but it appears that has not been enough to catch up with the high increase in demand for some of those skills. For example, from 1963 to 1982 the fraction of hours provided by by college educated workers grew by around 1% per year. But since 1983 this increase has reduced to less 0.5%, which could partially explain the steep increase in the college premium (and particularly the post-college premium). Why has this happened? One hypothesis is that the Vietnam War might have over-boosted college attendance as it helped people skip the draft. However, this sharp (and unnecessarily high for the market) increase in supply of highly educated workers reduced the wage of college educated workers. As the returns to college became smaller, the following young generations may have been misled to believe that college was not worth it. Even nowadays, there are claims of a "college bubble" where young people are wasting too much money to get a degree. Even though it is possible that some the knowledge acquired is not useful, the market rewards it. Figure 1 showed that skills are rewarded, and Figure 2 shows that these rewards outweigh the extra costs of college. The net value of college is at its peak. Nowadays, the message of the need to get more education appears to have gotten through as the supply of college graduates has started to increase faster.
Figure 2: Lifetime value of college relative to high school degree, net of tuition cost.
But if inequality itself - through the difference in wages - is what partially leads young generations to educate themselves, what is wrong with it? A market economy may need inequality to provide incentives but this may have other costs. Intergenerational mobility is a way to evaluate the degree to which individual economic fortunes depend on their parents - for example the likelihood that children born to a low-income family become high-income adults and vice-versa. High economic inequality need not have low intergenerational mobility if the society is dynamic, with lots of movement up and down the economic ladder. But one concern is that high inequality at one point in time may serve to reduce mobility over time, and hence create a dynastic society if currently wealthy households are able to "buy" success for their children. This way inequality could become self-perpetuating, even if it originally starts from simple high market returns to skill. Figure 3 shows that this is a real concern, as societies with more income inequality have lower intergenerational mobility. And countries with higher college premiums also tend to display lower mobility.
Figure 3: Income inequality and intergenerational mobility.
Original figure is from Corak (2013)
When the return to education is high, children of better-educated parents have two advantages. They are more likely to receive a higher education and they are more likely to be more rewarded for that when they become adults. And recent work by Chetty and others (also in a previous post), suggested that intergenerational mobility does not seem to have improving over time in the US. I think this is the biggest risk of inequality. Inequality per se is not the problem. The problem is poverty and lack of opportunities, but inequality could be a big driver of the persistence of these issues among a group of people who are "doomed" from the very beginning of their lives.
Based on an article by Autor.
A lot of attention (myself included) has been recently put on the Top 1% income and wealth. However, there is also substantial inequality in the other 99% that is worth exploring. To get an idea, if we took all the Top 1% income growth between 1979 and 2012 and distributed it among the other 99%, each of us (I assume you also belong to the other 99%...) would earn around $7000. However, the increase in the earnings gap between a college-educated and a high-school educated household is four times that in the same period. Hence, here we will focus on wage inequality among the other 99%, but particularly between the bottom 10% and top 90%, so as to exclude the very extreme cases (which deserve a different attention). But first, Figure 1 shows how wages have changed between 1963 and 2005 by wage percentile. Here we see that generally there was a much bigger increase in wages among the top half than the bottom one.
Figure 1: Change in real wages by percentile, 1963-2005.
A common measure for overall inequality is the ratio of those at the 90 and 10 percentiles. A typical issue is that the population might be changing its structure, with more people getting educated or more work experience. As this happens, the typical person in either of these percentiles might be changing, hence changing our standard interpretation of increasing inequality. Another take on inequality is to look at between-groups inequality, where the typical comparison is those with a college degree and those with a High School degree. This tries to avoid the issues of other characteristics of the population changing as in the overall inequality measure. However, another alternative look at inequality is to look within-groups, hence evaluating how much variation there is among small groups (for example: college educated, 25-30 years old, male). This three measures of inequality are displayed in Figure 2, where we see that even though the three of them have increased over the long haul, they have done so at different paces and through different paths. Particularly the college premium follows a strange path, increasing in the 1960s, decreasing in the 1970s and increasing very fast since the 1980s. This suggests that a simple, unique explanation for the recent increase in inequality is not likely to work.
Figure 2: Three measures of Income Inequality.
But has inequality changed more among the top or the bottom? An easy way to look at this is to compare the 90 and 50 percentiles (upper-tail inequality) and, separately, the 50 and 10 percentiles (lower-tail inequality). Note this still excludes the very bottom and very top. Figure 3 shows that even though lower-tail inequality grew in the 1980s, it has not grown since then. On the other hand, upper-tail inequality has increased continuously.
Figure 3: Upper- and Lower-Tail Inequality.
So what is behind this monumental increase in inequality? Identifying the cause of this change is very hard or probably impossible, but what we can do better is identify the proximate causes, meaning what seems to be closely associated with this change, even if we do not understand what led to the first thing. And this is where the skills of economists Autor, Katz and Kearney comes into play. They argue that we cannot simply think of people as belonging to one of two groups - skilled and unskilled - where the top one is associated with higher education. Figure 4 shows that from 1979 to 2005 the wages of those with a post-college education grew by a lot more than those with college degree. Moreover, the difference between those with exactly college and high-school degrees slowed down significantly since the 1980s. And finally, the difference between those with high school degrees and those without one has flattened or even decreased since the mid-1990s. All this suggests that, since the 1990s we are in a situation where the income among the very high- and very low-skilled workers has increased relative to those in the middle. Income has polarized.
Figure 4: Changes in wages by Education.
What explains this? The main hypothesis is that computerization has changed the demand for job tasks and affected the demand for skills in such a way that explains this polarization of income. Computers are good at doing routine tasks which are codifiable, like bookkeeping, clerical work or repetitive production tasks. (If you have interacted with a call-center lately, you will probably know how computers have improved in voice recognition and seem to have taken over those tasks that require gathering the same information all the time). On the other hand, abstract tasks like those performed by "high-skills" managers or educated professionals are hard to automatize since they require cognitive and interpersonal skills and adaptability. Similarly, manual tasks used in many "low-skilled" jobs like security guards, cleaners and servers are hard to computerize and hence have not been affected much by the advance of computers. Figure 5 confirms this intuition that low-skill jobs (taking the average education of those performing such jobs) usually have manual tasks. On the other end, high-skill jobs are mainly filled with abstract tasks. However, routine tasks are concentrated between the 20th and 60th percentiles.
Figure 5: Task intensity by Occupational Skill.
The conclusion is that the change in wage inequality may be substantially explained by changes in the demand of skills, which has been lately polarized by the introduction of computers. As the demand for these jobs increased, so did their wages. But why haven't workers matched the increase in demand by educating themselves more? Well, most likely this change was very hard to predict and so not enough people found higher-education to be "worth it." However, recent trends in education attainment suggest that young people are catching up to this increased demand.
Based on an article by Autor, Katz and Kearney.
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