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Understanding recent changes in the wage structure.

Increases in family income inequality during the 1980s have received prominent media attention over the last year. Some of the media focus on this topic clearly reflects election-year politics. But popular interest in income distribution also reflects the concerns of many Americans that the economic expansion of the mid- to late 1980s failed to benefit a substantial fraction of American families by enough to offset the losses incurred during the recessions of the early 1980s. In fact, data from the Bureau of the Census indicate that the real money incomes of the bottom 40 percent of American families were essentially no higher in 1989 than the incomes of the bottom 40 percent of families a decade earlier. In contrast, the incomes of the upper 20 percent of families in 1989 were almost 20 percent higher than those of the analogous families in 1979.(1) The enormous disparities in the fortunes of American families in the 1980s largely have been associated with labor market changes that have increased overall wage inequality and altered the wage structure in favor of more-educated and more-skilled workers. Although the recent recession of the early 1990s may or may not be remembered as a white collar recession, the expansion of the 1980s was certainly a white collar expansion.

Understanding changes in family income inequality requires understanding changes in the wage structure. NBER economists have attempted to document and explain recent and historical changes in the U.S. wage structure. My remarks focus on the conclusions that can be drawn from this research concerning: 1) the dimensions of recent dramatic wage structure changes in the United States; 2) the likely causes of these changes; and 3) the extent to which similar changes are occurring in other advanced industrial nations.

A major cause of rising wage inequality and increased educational wage differentials since the 1970s is a strong secular shift in relative labor demand favoring more-educated workers and workers with problem-solving skills. This shift in labor demand is driven primarily by two forces: the increased internationalization of the U.S. economy, and skill-biased technological change, associated in part with the computer revolution. Similar changes in relative labor demand favoring more-educated workers appear to have occurred in other OECD countries. But not all OECD nations have experienced sharp increases in wage dispersion and educational wage premiums as the United States has. National differences in wage-setting institutions and in training and education systems appear to lead to quite different changes in wage structure in response to a similar set of market-driven shifts in demand.

Wage dispersion among both men and women increased substantially in the United States during the 1980s. The hourly earnings of the 90th percentile full-time worker relative to the 10th percentile full-time worker increased by approximately 20 percent for men and 25 percent for women from 1979 to 1989. Changes in the wage structure along three dimensions contributed to rising wage inequality. First, educational and occupational wage differentials expanded with a particularly sharp rise in the relative earnings of college graduates. The college wage premium doubled for young workers, with the weekly wages of young male college graduates increasing by approximately 30 percent relative to those of young males with 12 or fewer years of schooling. Second, the average wages of older workers increased relative to those of younger workers for those without college degrees. Third, wage dispersion increased greatly within narrowly defined demographic and skill groups. In other words, wage dispersion expanded among individuals of the same age, education, and sex, and it expanded among those working in the same industries and occupations. Much of this within-group increase in wage dispersion involved increases in wage differentials for "similar" work across establishments in the same industry. Both the identity of one's employer and one's formal educational qualifications matter more for one's earnings today than in the past. In fact, wage dispersion for males was greater at the end of the 1980s than at any time since 1940.

Since these wage structure changes occurred in a period of stagnation in overall real wage growth, the less-educated and the less-fortunate suffered substantial losses in real earnings relative to analogous individuals a decade earlier. The real hourly wages of young males with 12 or fewer years of schooling dropped by approximately 20 percent from 1979 to 1989. Finally, the one aspect of the wage structure that narrowed substantially during the 1980s was the gender gap, with the earnings of women increasing (typically by 10 percent or more) relative to men in all education and age groups from 1979 to 1989.

Although there is some disagreement about the causes of these wage structure changes, there is a broad consensus that wage inequality and "skill" differentials have increased sharply since the 1970s.(2) These facts have been documented and replicated by many researchers using many alternative data sources. Figure 1 provides a longer-term perspective on changes in the wage structure using data on relative hourly wages for full-time workers from the March Current Population Surveys. The key changes in the U.S. wage structure over the past 25 years can be summarized as follows:

1) The college wage premium rose from 1963 to 1971, fell from 1971 to 1979, and then rose sharply from 1978 to 1989. The changes in the college/high school wage ratio were greatest for the youngest workers in the 1970s and 1980s.

2) Experience differentials expanded substantially over the last 20 years. The most dramatic increases in experience differentials occurred for less-educated males from 1979-87.

3) Within-group (residual) wage inequality for men has been increasing steadily over the last 20 years. Overall wage inequality for men started to increase in the early 1970s, and the rate of increase accelerated in the 1980s.

4) After remaining fairly stable in the 1960s and 1970s, male/female wage differentials narrowed substantially from 1979 to 1990.

Thus, rising wage inequality for men started prior to the 1980s and was driven by rising within-group inequality in the 1970s. Both within-group inequality and educational wage differentials expanded dramatically in the 1980s.

NBER researchers have explored how to explain these changes with simple supply and demand models and to what extent one also must investigate changes in wage-setting institutions or pay-setting norms. A supply and demand framework that treats different demographic, education, and skill groups as imperfect substitutes in production does a good job of explaining changes in educational differentials over the last 30 years, but within-group inequality is much tougher to explain. Institutional changes from the late 1970s to the late 1980s (for example, product market deregulation, the decline of private sector unionization, and the erosion of real value of the federal minimum wage) appear to play some role in explaining rising wage inequality.

Most researchers conclude that demographic changes are not the major factor behind recent wage structure changes. In fact, the same groups with relative wage increases in the 1980s (college graduates and women) also experienced substantial increases in their relative numbers in the labor force. The positive correlation of relative wage and quantity changes among demographic groups in the 1980s strongly suggests that relative demand shifts or changes in the relative "qualities" of the different groups are necessary to understand recent wage structure movements. Furthermore, increased educational wage differentials and rising wage inequality occurred across all age cohorts of workers in the 1980s. These within-cohort increases in inequality even for cohorts educated more than 20 years ago strongly suggest that rising wage inequality largely does not reflect an alleged recent decline in the quality of primary and secondary education in the United States.

The key to understanding rising "skill differentials" appears to be a strong secular shift in relative labor demand favoring more-educated workers and workers with problem-solving skills. The industrial and occupational distribution of U.S. employment shifted substantially in favor of college graduates relative to noncollege workers and in favor of women relative to men during the 1970s and the 1980s. Employment declined in traditional goods-producing sectors that disproportionately employ blue collar males and expanded in professional, medical, and business service sectors that disproportionately employ college graduates.

These shifts reflect a long-term trend over at least the last 30 years in which the industrial and occupational distribution of employment has shifted in favor of college graduates relative to noncollege workers. The loss of high-wage, blue collar jobs in traditional goods-producing sectors may account for as much as one-quarter to one-third of the increase in the college/high school wage differential for males during the 1980s.(3)

Although much of this shift in relative demand can be explained by observed shifts in the industrial and occupational composition of employment toward relatively skill-intensive sectors, the majority reflects shifts in relative labor demand occurring within detailed sectors. Inside almost all sectors of the economy, firms are substituting more-educated for less-educated workers and are increasing their use of professional, managerial, and technical workers relative to production workers. These changes in factor ratios could arise from eliminating jobs done by those less-educated in the past, or from a shift in the production function caused by changes in technology, the organization of work, or government regulations affecting the demand for professional and administrative support services.

The increased internationalization of the U.S. economy has received much attention as a possible factor in widening educational and occupational wage premiums. NBER research has documented that both international trade and immigration operated to augment the nation's implicit supply of less-educated workers, particularly workers with less than a high school education, during the 1980s.(4) Many production and even routine clerical tasks can be transferred abroad much more easily than in the past. Trade-induced factors became important with the emergence of substantial trade deficits starting in the early 1980s.

Overall, the increased implicit supply of less-educated workers arising from trade deficits may account for as much as 15 percent of the increase in the college/high school wage differential from the late 1970s to the mid-1980s. But balanced expansions of international trade in which growth in exports matches the growth of imports appear to have fairly neutral effects on relative labor demand, and they appear to lead to some upgrading in the jobs for workers without college degrees, since export-sector jobs tend to pay higher wages for "comparable" workers than import-competing jobs do.

Immigration does not appear to have been a major factor in overall changes in the U.S. wage structure, but increased immigration in the 1980s may have played some role in the extremely poor labor market performance of high school dropouts. NBER researchers have focused on two approaches to examining the impact of immigration on the wage structure. The first is local labor market studies that compare changes in cities receiving many immigrants to those receiving few immigrants. A case study of the Mariel boatlift in Miami and other systematic cross-city studies show small impacts of immigrants on the wages of less-skilled workers.(5)

Nevertheless, immigration could affect aggregate supplies of relative skills and national trends in relative wages by skill groups, but the migration responses of natives to an influx of immigrants into a local labor market may mean that such comparisons will not show up in cross-city comparisons. The skill distribution of new immigrants into the United States in the 1980s was bimodal, with many highly skilled college graduates and many workers with very little formal schooling. The large influx of less-educated immigrants may have had some adverse impact on Americans with fewer than 12 years of schooling. In fact, recent research suggests that wage inequality increased most in the 1980s in the West, the region with the largest inflow of less-educated immigrants.(6) Overall, the direct effects of trade and immigration account for a sizable minority (perhaps 15 to 25 percent) of the increase in educational wage differentials in the 1980s.

A second primary suspect for recent changes in the wage structure is skill-biased technological change. The increased importance of microcomputers and computer-based technologies appears to favor more-educated over less-educated workers. In the U.S. manufacturing sector, increases in the relative employment of more-educated workers are strongly positively correlated with investment in computer technologies and R and D intensity.(7) A substantial wage premium for those who use computers on their jobs helps explain a substantial portion of the increase in the college wage premium in the 1980s.(8)

Overall, the evidence suggests that an unbalanced expansion of trade involving large trade deficits in manufactured goods, and technological changes favoring computer-literate workers with problem-solving skills, explain much of increased wage inequality and educational wage differentials in the United States. Noncollege-educated American workers are becoming increasingly substitutable with foreign workers and new computer technologies. Labor demand is shifting in favor of jobs for college graduates requiring problem-solving skills, and toward jobs that require the "customer-oriented" skills necessary for success in the service sector, Jobs that require direct human contact with customers (such as health services) can't be transferred abroad easily. The separate impacts of technological change and international trade are difficult to identify, since increased international competition could motivate firms to innovate, adopt new technologies, or change work organizations.

A rapid secular trend in relative demand favoring college graduates is apparent over the last 20 years. But the much more rapid growth in the relative supply of college graduates associated with baby-boom cohorts and the Vietnam War meant that supply growth more than offset demand growth in the 1970s, leading to a decline in the returns to college. Slower relative supply growth associated with baby-bust cohorts combined with accelerated demand growth fueled by the trade-deficit and microcomputer revolution led to an explosion in the college wage premium in the 1980s. The rise in the college wage premium has led to increases in college enrollment rates in recent years (especially for women) despite sharply rising tuition costs. Thus a more rapid growth in the supply of college graduates will tend to offset demand increases in the future. The steady increase in within-group inequality over the 1970s and 1980s is consistent with secularly rising relative demand for more-skilled workers as well as with institutional changes, such as declining unionization, that have generated increases in wage differentials for comparable workers across establishments.

The 1940s and the 1980s provide a nice historical contrast in terms of relative wage changes. Educational and establishment wage differentials and overall wage inequality decreased substantially in the 1940s.(9) Much of the narrowing of the wage structure was driven by the explicit policies of the National War Labor Board to reduce establishment wage differentials. The increased importance of unions also helped to raise blue collar wages. But market forces reinforced these patterns with a manufacturing boom that generated a strong demand growth for blue collar workers as well as a rapid growth in supply of more-educated workers. Institutional changes in the 1980s went in the opposite direction from those in the 1940s and reinforced market tendencies toward rising wage inequality.

Researchers in the NBER project on comparative labor markets have assembled data for many countries (including the United States, Great Britain, Canada, Australia, Japan, Sweden, France, Italy, Germany, Spain, South Korea, and the Netherlands) to systematically compare changes in wage structure among industrial economies.(10)

All of the countries studied, including the United States, shared a common pattern of narrowing educational and occupational wage differentials from the late 1960s to the late 1970s. With the exception of the United States, all countries experienced a decline in overall wage dispersion for males during the 1970s. The tendency toward reduced educational wage differentials and a more compressed wage structure had ceased in all OECD countries by the mid-1980s. But the patterns of wage structure changes differed widely among OECD countries during the 1980s.(11)

Most countries experienced increased wage inequality and increased educational differentials, but the magnitudes of these increases were much smaller than in the United States. The one country with a pattern of widening wage differentials that is both quantitatively and qualitatively similar to the United States is Great Britain. Canada, Australia, Japan, and Sweden have had modest increases in wage inequality and occupational differentials since the early 1980s. Wage differentials continued narrowing in Italy and France through the mid-1980s with some hint of expanding differentials in the late 1980s. There is no evidence of rising wage inequality or educational differentials during the 1980s in either Germany or the Netherlands. Additionally, increased wage inequality in other countries (such as Britain and Japan) has been associated with generally rising levels of real wages, so that real earnings for the bottom half of the distribution have not declined precipitously as they have in the United States.(12)

While changes in the distribution of wages differed substantially among OECD countries in the 1980s, changes in the distribution of jobs were fairly similar. All the countries examined had large, steady shifts in the industrial and occupational distribution of employment over the past two decades toward sectors and jobs that disproportionately use more-educated workers. In fact, the share of employment in manufacturing declined substantially in all the countries except Japan during the 1980s. This suggests that broad economic forces arising from changes in technology and increased internationalization of economic competition have strongly shifted labor demand in all advanced OECD economies in favor of more-educated workers and those with problem-solving skills and against noncollege-educated workers. Despite shifts in labor demand favoring more-educated workers, skill differentials narrowed in the 1970s because of dramatic increases in the supply of highly educated workers associated with rapid expansions of higher education systems, and because of explicit government and union policies to narrow earnings differentials. Similar demand shifts in favor of the more-educated translated into quite different wage structure changes in the 1980s, depending on a nation's educational and training systems and wage-setting institutions.

The experiences of other OECD nations indicate that increased international competition and the implementation of new technologies do not lead inevitably to sharp increases in wage inequality and substantial declines in the real earnings of less-educated workers. Two types of national strategies have been associated with little increase in skill differentials and overall wage inequality in the 1980s. The first is the continental European pattern of explicit government intervention in the wage-setting process through increases in minimum wages and extensions of the terms of collective bargaining agreements to firms not directly involved in such agreements. Strategies of this type succeeded during the early 1980s in preventing the wage structures from widening in Italy and France. But these types of policies do not deal directly with the profound changes in the demand for skills.

Eventually they run into serious economic and political difficulties. Policies that directly operate to prohibit market wage adjustments without directly addressing changed labor market conditions can prevent wage inequality from increasing for a while, but they eventually are associated with stagnant employment growth, persistent unemployment for young workers (as in France), and/or a shift of resources to an underground economy to avoid wage regulations (as in Italy).

The impact of changing relative skill demands on the wage structure also depends on a nation's educational and vocational training systems. Germany and Japan have educational and training systems that invest heavily in noncollege-educated workers. German and Japanese firms act as if college-educated and other workers were much closer substitutes in production than U.S. or British firms do. The same technology and trade shocks show up less in relative skill demand, and do not generate as much pressure for wage structure changes in these countries.

In summary, the wage structure widened notably in the United States over the last 20 years. Changes in relative labor demand from internationalization and technological changes appear important. U.S. labor market institutions mean these changes translate more directly into wage structure changes than in countries with more centralized wage bargaining and more direct government regulation of wages. These relative wage changes have been a major part of rising inequality of family incomes in the United States.

1 U.S. Bureau of the Census, Money Income of Households, Families, and Persons in the United States: 1991, Current Population Reports, Series P-60, No. 180, Washington, DC: U.S. Department of Commerce, August 1992.

2 J. Bound and G. E. Johnson, "Changes in the Structure of Wages in the 1980s: An Evaluation of Alternative Explanations," American Economic Review 82 (June 1992), pp. 371-392; S. J. Davis and J. C. Haltiwanger, "Wage Dispersion Within and Between Manufacturing Plants, 1963-86," NBER Working Paper No. 3722, May 1991, and Brookings Papers on Economic Activity: Microeconomics (1991), pp. 115-180; M. Kosters, "Wages and Demographics," in M. Kosters, ed., Workers and Their Wages, Washington, DC: American Enterprise Institute, 1991; F. Levy and R. Murnane, "U.S. Earnings Levels and Earnings Inequality: A Review of Recent Trends and Proposed Explanations," Journal of Economic Literature, forthcoming; and K. M. Murphy and F. Welch, "The Structure of Wages," Quarterly Journal of Economics 107 (February 1992), pp. 285-326.

3 L. F. Katz and A. L. Revenga, "Changes in the Structure of Wages: The United States versus Japan," NBER Reprint No. 1354, February 1990, and Journal of the Japanese and International Economies 3, 4 (December 1989), pp. 522-553; and Bound and Johnson, "Changes in the Structure of Wages...."

4 G. J. Borjas, R. B. Freeman, and L. F. Katz, "On the Labor Market Effects of Immigration and Trade," NBER Working Paper No. 3761, June 1991, and in G. J. Borjas and R. B. Freeman, eds., Immigration and the Work Force, Chicago: University of Chicago Press, 1992, pp. 213-244.

5 D. Card, "The Impact of the Mariel Boatlift on the Miami Labor Market," NBER Working Paper No. 3069, August 1989, and Industrial and Labor Relations Review 43 (January 1980), pp. 245-257.

6 R. H. Topel, "Wage Inequality and Regional Labor Market Performance in the United States," paper presented at NBER Labor Studies Meeting, Cambridge, MA, November 1992. See "Bureau News" in this issue.

7 E. Berman, J. Bound, and Z. Griliches. "Changes in the Demand for Skilled Labor Within U.S. Manufacturing Industries: Evidence from the Annual Survey of Manufacturing," NBER Working Paper No. 4255, January 1993.

8 A. B. Krueger, "How Computers Have Changed the Wage Structure: Evidence from Microdata, 1984-9," NBER Working Paper No. 3858, October 1991.

9 C. Goldin and Robert A. Margo, "The Great Compression: The Wage Structure in the United States at Midcentury," NBER Working Paper No. 3817, August 1991, and Quarterly Journal of Economics 107 (February 1992), pp. 1-34.

10 R. B. Freeman and L. F. Katz, "Differences and Changes in Wage Structures," forthcoming as an NBER volume to be published by the University of Chicago Press.

11 L. F. Katz, G. Loveman, and D. G. Blanchflower, "A Comparison of Changes in the Structure of Wages in Four OECD Countries," Harvard University, July 1992; R. B. Freeman and K. Needels, "Skill Differentials in Canada in an Era of Rising Labor Market Inequality," NBER Working Paper No. 3827, September 1991; P.-A. Edin and B. Holmlund, "The Swedish Wage Structure: The Rise and Fall of Solidarity Wage Policy," NBER Working Paper No. 4287, January 1993; K. G. Abraham and S. Houseman, "Earnings Inequality in Germany," C. Erickson and A. Ichino, "Wage Differentials in Italy: Market Forces, Institutions, and Inflation," and R. Gregory and F. Vella, "Aspects of Real Wage and Employment Changes in the Australian Male Labour Market," papers presented at NBER Conference on Differences and Changes in Wage Structures, Cambridge, MA, July 1992; and J. Hartog, H. Oosterbeek, and C. Teulings, "Age, Wage, and Education in the Netherlands," University of Amsterdam, unpublished paper, 1992.

12 Katz, Loveman, and Blanchflower, "A Comparison of Changes...."
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Author:Katz, Lawrence F.
Publication:NBER Reporter
Date:Dec 22, 1992
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