1

The Wage Structure

2

Introduction and Overview

• Explain the positive skew in earnings distribution.

• Understand wage inequality in the United States.– The facts: patterns and trends in the data.– The explanations: factors that have led to increased

inequality.

3

Basic Shape of the Wage Distribution

Positively skewed:

Frequency

Wage

Human capital theory can explain the shape of this distribution.

4

Distribution of Ability

Worried? http://www.iqtest.com/

5

Human Capital Theory

• Individual’s with the highest ability have the greatest incentive to invest.

• This stretches out the earnings distribution at the top end.

Years of Schooling

$

MRR1

r

S2S1

MRR2

6

Measuring Inequality1. The spread between wages at different percentiles of wage

distribution is a measure of wage dispersion.

w10 w90Wagew10 w90

Density Density

Wage below which 90% of population earnsWage below which 10%

of population earns

7

Measuring Inequality2. Percent change in wages from 1963 to 1995:

Why does this equal the percentage change in average wages?=ln[w95/w63]

=ln[w95/w63-w63/w63+1]

Recall that ln(x+1)≈x when x is small. Thus,

Can look at changes at different points in the earnings distribution.

For example: One can examine the percentage change in wages at the 10th, 50th and 90th percentile of the wage distribution.

8

Percent Change in Weekly Wage by Percentile, 1963-1995

9

Percent Change in Weekly Wage by Percentile, 1963-1995

10

Timing of Increasing Inequality

11

International Comparisons

Percentage Difference Between Wage at 90th and 10th Percentile

(Males in Selected OECD Countries)

00.20.40.60.8

11.21.41.6

1979 1984 1989 1994

Year

Rat

io (%

Diff

eren

ce)

Australia

Norway

Japan

UK

USA

12

Explaining Increased Inequality

In theory: two possible reasons:– Increases in the dispersion of skills.– Increase in the returns to skills.– Note: Some skills are observable to researchers (education,

experience), others are unobservable to researchers (motivation, charisma).

We will start by looking at changes in the returns to observable skill . . .

13

Trend in Educational Wage Gap

14

Wage Growth by Demographic Group, 1963-1995

Group Percent Change in Real Wage

Men 0.9

Women 17.1

Education

Less than high school -4.4

High school 5.7

Some college 4.5

College 25.1

15

Changes in the Returns to Experience

16

What are residual wages?

Education (X)

Log Wage

• •

•

• •

• •

•

•

• •

• •

•

•

•

•

Regression LineSlope=β

wage residual (u)

α

i i iW X u

17

Increasing Residual Wage Dispersion

•

•

• • •

•

• •

• •

Education

Log Wage

•

•

•

•

•

•

• •

•

•

Education

Log Wage

Over time, we have seen increasing residual wage dispersion.

18

Changes in Residual Wage Gap

Residual Wage: wage after controlling for age, education, experience and region of residence.

19

Where Have Changes Occurred?

• Observable skill quantities (Xi=education, experience)– Increasing spread in educational attainment– Increasing spread in experience

• Returns to observable skill (β)• Returns to unobservable skill (ui) 

 Percentage Change in the 90th-10th Wage Differential

i i iW X u

  Total Change

Observed Skill

Quantities

Observed Skill

Returns

UnobservableSkill

1964-1988 .373 .035 .128 .208

Juhn, Murphy, Pierce 1993

20

Why Did Wage Inequality Increase?

• Demand-side factors– –

• Supply-side factors– – –

• Institutional factors – – –

21

Demand-Side Factors

Relative EmploymentOf Skilled Workers

Relative Wage Of Skilled Workers S

D0

e0

w0

D1

w1Major Demand Factors1. Skill-Biased Technological Change2. Globalization and Trade

• Imports hurt less-skilled• Exports benefit more-skilled

22

Supply-Side Factors

Relative EmploymentOf Skilled Workers

Relative Wage Of Skilled Workers S0

D0

e0

w0

Major Supply Factors1. Cohort size (i.e. the Baby Boomers)2. Female Labor Force Participation3. International Immigration

• Influx of low-skilled immigrants in the 1980s but not big enough to cause relative supply of skilled workers to fall.

S1

w1

23

Shifts in Supply and Demand

Relative EmploymentOf Skilled Workers

Relative Wage Of Skilled Workers S0

D0

e0

w0

D1

w*

Demand shifts must outweigh supply shifts

e*

S1

24

Institutional Factors:Industry Wage Differentials

• Fact: Workers in some industries earn more than workers in other industries.– True even after controlling for observable worker differences.

• During the 1980s:– The proportion of less-educated workers in low-paying industries – The proportion of highly-educated workers in high-paying industries

• Also, industry wage differentials

• This might explain part of the reason why the returns to education appears to have increased.

25

Institutional Factors Decreases in Unionization

• Fact: Unions tend to increase wages by as much as 15%.

• Union membership for men 1973-74 = 30.8%• Union membership for men 1993 = 18.7%

• Changes by Education:– Less educated men =– College graduates increased slightly.

• Thus, the decline in unionization for workers with less education may also explain part of the increase in the returns to education.

26

Institutional Factors:Decline in the Real Value of the

Minimum Wage

• Real value of minimum wage has eroded over time.• Less-educated workers most often earn minimum wage• Could explain drop in wages of less educated relative to wages of

more educated.