Monday, May 21, 2007

Why Is Income Inequality in America So Pronounced? Consider Education

By Tyler Cowen

The most commonly cited culprits for the income inequality in America — outsourcing, immigration and the gains of the super-rich — are diversions from the main issue. Instead, the problem is largely one of (a lack of) education.

The extent of outsourcing, for instance, is not yet high enough to have much effect on American wages. Even if a call center is set up in India, this helps American business expand at home. Most generally, the net flow of investment is into the United States, not away from it. It appears that more American jobs are “in-sourced” than outsourced.

Nor should we be distracted by the gains of the top 1 percent. The goal should be to elevate the poor, not knock down the tall poppies. Microsoft has created cheap software and many jobs, and its co-founder, Bill Gates, is giving away most of his fortune.

For the economy as a whole, labor’s share of national income has stayed roughly constant at just above 70 percent. What has changed is that highly skilled laborers earn more labor income than low-skilled workers.

Many of the very wealthy have built their fortunes by taking companies private, buying the right securities at the right time or running successful hedge funds. Arguably, these activities improve the allocation of capital and thus enhance productivity.

But even if these individuals perform no socially useful function, their gains reallocate wealth from one class of investors to another. That is, one group of investors reaps profits by buying in first and bidding up equity prices, thereby causing later investors to pay more for the same companies. This process transfers value from the relatively wealthy to the extremely wealthy, but it doesn’t much hold back the poor.

Nor are recent changes in equality about the tax system. Whatever one thinks of President Bush’s reductions in marginal tax rates, pretax incomes also show greater inequality.

Immigration has a smaller influence on wages than is often believed as well. Claudia Goldin and Lawrence F. Katz, both professors of economics at Harvard, estimate the numbers in their recent paper, “The Race Between Education and Technology: The Evolution of U.S. Educational Wage Differentials, 1890 to 2005,” soon to be expanded into a book.

College graduates have been gaining relative to high school graduates. But competition from immigrant labor accounts for only 10 percent of the change in the wages of unskilled workers, relative to the skilled, since 1950.

Starting about 1950, the relative returns for schooling rose, and they skyrocketed after 1980. The reason is supply and demand. For the first time in American history, the current generation is not significantly more educated than its parents. Those in need of skilled labor are bidding for a relatively stagnant supply and so must pay more.

The return for a college education, in percentage terms, is now about what it was in America’s Gilded Age in the late 19th century; this drives the current scramble to get into top colleges and universities. In contrast, from 1915 to 1950, the relative return for education fell, mostly because more new college graduates competed for a relatively few top jobs, and that kept top wages from rising too high.

Professors Goldin and Katz portray a kind of race. Improvements in technology have raised the gains for those with enough skills to handle complex jobs. The resulting inequalities are bid back down only as more people receive more education and move up the wage ladder.

Income distribution thus depends on the balance between technological progress and access to college and postgraduate study. The problem isn’t so much capitalism as it is that American lower education does not prepare enough people to receive gains from American higher education.

Bottlenecks currently keep more individuals from improving their education. Professor Katz has suggested changes at multiple levels, including additional college aid, more-accessible community colleges, easier financial aid forms, more serious attempts to identify and retain top teachers in high schools and school voucher experiments.

It doesn’t suffice simply to increase the number of people in college; rather the new students must be prepared to learn. There is, however, no single magic bullet.
Pessimists like Charles Murray, co-author of the much-debated 1994 book “The Bell Curve,” have argued that only so many individuals are educable at a high level. If that were the case, current levels of inequality might be here to stay.

But the evidence suggests that when additional higher education becomes available, it offers returns in the range of 10 to 14 percent per year of college, at least for the first newcomers to enroll.

Nonetheless it will, sooner or later, become increasingly difficult to deliver the gains from college — not to mention postgraduate study — to the entire population. Technology is advancing faster than our ability to educate. So even if inequality declines today, it may well intensify in the future. Even if American education improves at every level, the largely not-for-profit educational sector may simply be less dynamic than the progress of new technologies.

The lesson is this: Economists are homing in on the key to the inequality problem, but don’t think any solution will necessarily last for long.


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