Growing Wage Inequality Is Caused by Growing Skill Inequality

By Edward P. Lazear

Tuesday, August 04, 2020

 

In recent years, the gap between the highest and lowest income brackets has become an area of growing concern for economists and policymakers, not to mention the low-wage workers who have been left behind. In late 2013, President Obama said that inequality was the defining issue of our time.

 

Growing inequality, however, is neither a new phenomenon nor one that adversely affects only the poor. Over time, the earnings of the top 10 percent have steadily moved away from those of the median worker. In the 1980s, the top 10 percent earned about two times as much as the median worker. Now, the top 10 percent earns roughly 2.5 times as much as the median worker — a 25 percent increase.

 

Is growing inequality the fault of capitalism, of a growing ability of American firms to exploit their workers, or of increasing greed? Both the international and domestic evidence is inconsistent with those explanations. In fact, the growing wage gap seen in the US is common to most developed economies. Top earners have enjoyed higher wage growth than the median worker throughout the OECD countries. A subset of institutionally and political diverse countries, including the United Kingdom, Germany, Denmark, Sweden, Norway, Finland, Switzerland, Australia, New Zealand and Canada among others, have all experienced growing wage inequality similar to that seen in the United States. If such varied countries — some of which are held out as examples of the social-democratic ideal — are all seeing growing wage dispersion, it is unlikely that capitalism, increased monopoly power, or growing greed is the cause.

 

If not capitalism per se, what is the explanation for growing wage inequality? The answer is increasing dispersion in labor-market productivity. In labor markets where firms must compete with one another to hire and retain workers, wages tend to reflect a worker’s productivity. The evidence supporting this linkage is strong. If wages at the bottom are not growing as rapidly as wages at the top, perhaps productivity among the least skilled workers is not growing as rapidly as productivity among the most skilled workers. In fact, that is exactly what appears to be happening.

 

Industries vary in their use of skilled workers. For example, in the Bureau of Labor Statistics’ “Apparel Manufacturing” industry, the average level of education is 11.7 years. In “Information Services and Data Processing Services,” it is 15.5 years. Those industries that have the most educated workers have the highest levels of productivity measured as total value added per hour worked. Those same industries also tend to have witnessed the greatest growth in productivity over the past two decades. In fact, the differences in productivity growth between educated and less-educated workers far outstrips the differences in wage growth between educated and less-educated workers. This evidence suggests that wages are lagging for the lowest half of American workers primarily because productivity growth is lagging for those workers.

 

The productivity gap is an explanation, but it is not a justification. Even though the growth in wage inequality is explained by a growth in productivity inequality, that does not mean that the problem can be ignored. It has little to do with capitalism, exploitation or greed, but it remains a problem nonetheless.

 

What can be done about it? To eliminate the growing gap in wages, it is necessary to eliminate the growing gap in productivity. The only solution is to increase both the amount and quality of education obtained by those falling behind. Elsewhere, I have argued that a move in the direction of the vocational-schooling model would be beneficial to both productivity and wages. In Germany, which is known to have highly developed and effective vocational training, workers with vocational apprenticeships earn about 92 percent of the average domestic wage, whereas American high-school grads earn only 70 percent of the average American wage. Data show that over the past 15 years Germans with vocational apprenticeships have been considerably better off than their American counterparts. Americans who finish only high school or, worse, drop out before completion, do not have the skills necessary to make them productive in a modern economy. Providing the option of skills-based training to our high-school and community-college students could better equip them to earn higher wages.

 

Much vocational training is in service industries, not manufacturing or construction, so the vocational model need not force young people into blue-collar occupations, although it should be noted that many blue-collar occupations pay more than jobs requiring higher levels of education.

 

As technology speeds up and artificial intelligence becomes more prevalent, exacerbating the problem of skill inequality, lower wage workers will fall even further behind. Rather than condemning capitalism, claiming monopolistic exploitation of the poor, or blaming increasing greed, we should focus on providing the skills necessary to make all workers productive and high-earning members of the modern economy.