Maybe The Earnings Gap Isn't Such A Bad Thing

Income inequality grew substantially during the Reagan and Bush Presidencies, yet the midterm elections suggest voters did not hold this against the Republican Party. The reason may be because they realize that the increase in inequality is related to economic growth. When greater inequality is due to higher rates of return on human capital and other investments in knowledge, it can be an engine that drives an economy toward more rapid economic growth.

Ever since Jean-Jacques Rousseau's Discourse on the Origin and Foundations of Inequality (1755), the emphasis has been almost exclusively on the negative aspects of income inequality. But in modern economies, growth requires an educated and trained labor force, since production of computers, other electronics, and most manufactured goods and services needs knowledgeable workers. An economy grows faster when rates of return on investments in human capital increase, or when the amount invested expands.

The increased earnings gap during the past two decades in the U.S. is mainly the result of higher returns on education, training, and experience. This didn't happen because of Presidential or congressional policies but because companies competing for skilled workers bid up their pay compared with the wages of less-skilled workers.

GRADUATION GIFT. Starting in the 1970s and continuing unabated until the end of the '80s, the gap between the weekly earnings of college and high school graduates rose from about 40% to some 70%, while the premium on completing high school pushed up to over 30%. Similar trends raised the compensation of older and more experienced employees compared with that of younger and newer workers. These trends toward higher benefits from knowledge slowed during the past few years, but they have not reversed direction.

Most Western European countries experienced related trends in earnings differences by education and job skills. Labor markets are not as flexible there, so the gap in weekly earnings between more and less knowledgeable employees rose less in Europe, while unemployment rates of younger and other less trained workers increased much more than in America.

The widening inequality in earnings and the buoyant demand for skilled workers also indirectly encourages greater growth in the economy by increasing the incentives for young people to invest in themselves. That's one reason why government data shows high school graduation rates of blacks in the U.S. have risen substantially since the late 1970s to the point that they are now close to the very high rates of whites.

HIGHER ENROLLMENTS. And despite the rapid increase in college tuition since 1980, the fraction of male high school graduates who continued their education grew by several percentage points, while college enrollment rates of women expanded even more rapidly. Students from poorer families were hurt by cutbacks during the 1980s in federal grantq to college students, but a study by Thomas J. Kane of Harvard University shows that college enrollment rates of blacks rose sharply during the latter part of the 1980s after falling earlier in the decade.

Unfortunately, the higher returns on human capital have been associated with deteriorating earnings for persons at the bottom of the economic ladder. Real earnings of high school dropouts and others with few skills not only declined relative to more educated and trained employees but also fell by a lot in absolute terms. This explains why the labor-force participation rates of unskilled groups have dropped noticeably since the latter part of the 1970s while the number of jobs have expanded dramatically.

This makes it even more essential to help young persons from poorer families overcome any artificial obstacles to improving their education and training. State, local, and federal governments can help with policies that do not require greatly increased public spending. States can improve the quality of high schools in low-income neighborhoods by raising the competition among schools for students. I believe the best way to accomplish this is by offering tuition vouchers tm students from poor families that they can use at private as well as public schools.

The federal government has a limited but valuable role to play in raising skills. Its loan program to college students should be expanded. At the same time, however, strenuous efforts are needed to reduce the embarrassingly high delinquency rate on past loans to students.

Everyone, from government to the intellectuals, must rethink the pluses and minuses of income disparities.

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