Is the Increased Earnings Inequality among Americans Bad? BECKER
Income inequality widened, particularly between urban and rural households after China began its rapid rate of economic development in 1980. At the same time, the fraction of Chinese men, women, and children who live on less than $2 a day--the World Bank's definition of poverty--greatly fell. Few would argue that the poor in China did not become much better off due to the rapid economic development, even though the gap between their incomes and those of the middle and richer classes widened by a lot. A similar conclusion would apply to India as the explosion in its general economic development during the past 20 years widened the gap between rich and poor, but raised the income levels of the very poor.
I make this observation in reaction to the great concern expressed by politicians and many others in the United States over the rather substantial increase during the past 25 years in earnings inequality among Americans. The China and India examples illustrate that whether rising inequality is considered good or bad depends on how it came about. I believe that the foundation of the growth in earnings inequality of Americans has mainly been beneficial and desirable.
The basic facts are these. There has been a general trend toward rising gaps between the earnings of more and less skilled persons. With regard to education, real earnings (that is, earnings adjusted for changes in consumer prices) earnings of high school dropouts did not change much. Earnings of high school graduates grew somewhat more rapidly, so that the gap between dropout and graduate earnings expanded over time.
The main action came in the earnings of college graduates and those with postgraduate education. They both increased at a rapid pace, with the earnings of persons with MBA's, law degrees, and other advanced education growing the most rapidly. All these trends produced a widening of earnings inequality by education level, particularly between those with college education and persons with lesser education. I should also note that while an upward trend in the earnings gap by education is found for both men and women, and for African Americans and whites, the earnings of college educated women and African Americans increased more rapidly than did those of white males. As a result, inequality by sex and race, particularly among college educated persons, narrowed by a lot.
As the education earnings gap increased, a larger fraction of high school graduates went on to get a college education. This trend toward greater higher education is found among all racial and ethnic groups, and for both men and women, but it is particularly important for women. The growth in the number of women going to and completing college has been so rapid that many more women than men are now enrolled as college students. Women have also shifted toward higher earnings fields, such as business, law, and medicine, and away from traditional occupations of women, such as K-12 teachers and nurses. The greater education achievement of women compared to men is particularly prominent among blacks and Latinos.
The widening earnings gap is mainly due to a growth in the demand for educated and other skilled persons. That the demand for skilled persons has grown rapidly is not surprising, given developments in computers and the Internet, and advances in biotechnology. Also, globalization increased the demand for products and services from the U.S. and other developed nations produced by college educated and other highly skilled employees. Globalization also encouraged a shift to importing products using relatively low-skilled labor from China and other low wage countries instead of producing them domestically.
Rates of return on college education shot up during the past several decades due to the increased demand for persons with greater knowledge and skills. These higher rates of return induced a larger fraction of high school graduates to get a college education, and increasingly to continue with postgraduate education.
Some of you might question whether rates of return on higher education did increase since tuition grew rapidly during the past twenty-five years. However, increases in tuition were mainly induced by the greater return to college education. Pablo Pena in a PHD dissertation in progress at the University of Chicago argues convincingly that tuition rose in part because students want to invest more in the quality of their education. Increased spending per student by colleges is partly financed by higher tuition levels.
This brings me finally to the punch line. Should not an increase in earnings inequality due primarily to higher rates of return on education and other skills be considered a favorable rather than unfavorable development? Higher rates of return on capital are a sign of greater productivity in the economy, and that inference is fully applicable to human capital as well as to physical capital. The initial impact of higher returns to human capital is wider inequality in earnings (just as the initial effect of higher returns on physical capital is widen income inequality), but that impact becomes more muted and may be reversed over time as young men and women invest more in their human capital.
I conclude that the forces raising earnings inequality in the United States is on the whole beneficial because they were reflected higher returns to investments in education and other human capital. Yet this is not a ground for complacency, for the responses so far to these higher returns is disturbingly limited. Why have not more high school graduates gone on for college education when the benefits are so apparent? And why did the fraction of American youth who drop out of high school, especially African American and Hispanic males, remain quite constant at about 25 per cent of all high school students?
The answer to both questions lies partly in the breakdown of the American family, and the resulting low skill levels acquired by children in broken families. Cognitive skills tend to get developed at very early ages, while my colleague, James Heckman, has shown that non-cognitive skills, such as study habits, getting to appointments on time, and attitudes toward work, get fixed at later, although still relatively young, ages. High school dropouts certainly appear to be seriously deficient in the non-cognitive skills that would enable them to take advantage of the higher rates of return to greater investments in education and other human capital.
So instead of lamenting the increased earnings gap by education, attention should focus on how to raise the fraction of American youth who complete high school, and then go on for a college education. These pose tough challenges since the solutions are not cheap or easy. But it would be a disaster if the focus were on the earnings inequality itself. For that would lead to attempts to raise taxes and other penalties on higher earnings due to greater skills, which could greatly reduce the productivity of the world's leading economy by discouraging investments in human capital.