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Education and Income Distribution

So, it’s back-to-school time and thousands of first year students begin
their quest to become college graduates. As loans and tuition payments
mount, it may be a good idea to see if the high cost of college is really
worth it. The simple answer is yes: even the most expensive colleges are
a bargain.

Increasingly, it seems as though a college education is becoming a necessary
requirement for obtaining a decent piece of the economic pie. Over the
past couple of decades the distribution of income has been growing more
and more unequal: the top end of the distribution has seen a growth in
their income while those at the lower end have seen their real incomes
stagnate. To get an idea of the skewed distribution, the top 1% of households
own 30% of the wealth in the US and are on average 875 times as wealthy
as those in the bottom 40% of the distribution. It pays a lot to
be in the top part of the distribution.

Education is the most important way in which people can make it into
the upper end of the income distribution.

Just the Facts: Where are we now?

There are a number of ways to measure inequality in the economy. Three
ways to slice the data include looking at people’s Labor Earnings, Total
Income, and Wealth. Labor Earnings are simply the amount of salary taken
home as a result of working. Total Income includes labor earnings and adds
income from assets, such as stocks or savings accounts, and income from
government transfers, like Social Security or Welfare benefits. Finally,
Wealth represents the total stock of past savings.

The following table looks at the earnings, income, and wealth for college
graduates, high-school graduates, and those without a high-school diploma.
As you can see, going to college makes a huge difference in economic
outcomes. The average college graduate earns about $45,000 more per year
than those with only a high school education.


Averages (1992$)
Earnings Income Wealth
College 60,231 81,188 353,270
High school 27,225 36,694 136,923
No High school 10,236 20,146 68,275
Total 33,074 45,924 184,308

source: Diaz-Gimenez,
Quadrini, and Rios-Rull
(1997) using the Survey
of Consumer Finances
(1992 wave).

What is causing the growth in inequality?

There are two leading theories as to why the return to a college education
has been growing: increased international competition and skill-biased
technological change.

The first theory focuses on the globalization of the U.S. economy and
seems to be popular with an odd coalition of politicians from the far right
and far left. The logic is that increased competition from low skilled
labor abroad has driven down the wages of lower skilled workers at home.
Opposition to the NAFTA has been the the most outward manifestation of
these feelings.

On the surface, this theory seems to make some sense. Unfortunately,
the numbers don’t seem to add up (Paul
of MIT has been the leading voice in debunking the globalization
idea). The reason is that only a small portion of the US economy is actually
subject to competition from abroad, which means only a modest effect on
the average wages low skilled workers. Another fact pointing against
this theory is that inequality is growing in both the most and the least
trade-affected industries at approximately the same rate. So something
else must be going on.

The second leading explanation for the increase in inequality has been
called “skill-biased technological change”. The idea here is that, unlike
technological progress in the past, current technology favors the higher-skilled,
higher-educated worker over lower-skilled workers. For example, while the
increase in the use of computer technology helps the productivity and wages
of computer users and programmers, it does nothing to help the stagnating
wages of lesser educated workers who cannot use the new technology.

One problem with this theory is that it is hard to verify whether or
not this is really the correct explanation. Technological growth is a notoriously
hard thing to measure, as are “skills”. Breaking a amorphous quantity into
two hard to define components is not a trivial task. So, it is hard to
tell if this is a correct story ot not.

If this is the right answer, then going to college and obtaining a high
level of skills becomes an important ingredient in becoming a success in
today’s economy.


The overall issue of the growth of inequality in economic outcomes is
one that will most likely remain with us for awhile to come. For the time
being it seems like the best course of action is to get people into, and
through, colleges. The table should be plenty of motivation to get the
incoming students through the four years.

The price of not going to college is even higher than the price of tuition.

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Filed under: Economics