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What Can Be Done about the Widening Income Gap?


Christopher H. Wheeler
Wednesday, October 1, 2008

A common mantra among politicians is that the rich are getting richer while the poor are getting poorer. Data point to a dramatic rise in income inequality in the United States between 1980 and 2006.

The findings were published this summer in Earnings Inequality within the Urban United States: 2000-2006, which examines hourly labor earnings for 298 U.S. metropolitan areas-including St. Louis, Little Rock, Louisville and Memphis. The full report is available here.

The data on the whole indicate that there is an ever-widening wage gap between those at the top end of the pay scale and workers at the low end. The rise in wage inequality has been driven by such factors as educational attainment, e.g., high school versus post-baccalaureate degrees. Based on an analysis of inequality, some of the most important correlates of rising inequality between 2000 and 2006 were found to be:

  • decreasing manufacturing,
  • rising fractions of foreign-born workers (which are possibly associated with increased numbers of low-skill workers),
  • rising rates of unemployment and
  • increased fractions of workers with advanced degrees.

These findings generally support theories that the wage gap is widening because of changes in industrial structure, rising low-skill labor supply and skill-biased technological change.

What Can Policymakers Do?

Evidently, since much of the rise in inequality is associated with the supply of and demand for workers with high levels of skills, inequality is probably best handled by increasing the fraction of workers with high levels of education.

Of course, while helping workers at the bottom end of the distribution acquire human capital would undoubtedly help raise the lower end of the wage distribution, increasing the total supply of highly skilled workers may exacerbate inequality, at least in the short run. An increase in the number of workers with advanced degrees may create even greater bias for the highly skilled and enhance their earnings-while leaving behind those with lesser education.

Over time, however, as workers with high levels of schooling become the majority of the American labor force, the degree of homogeneity among workers increases. In addition, the extent to which employers are forced to bid for relatively few high-skill employees will decrease, dampening growth at the top end of the earnings scale.

Policies aimed at influencing skills are probably more desirable than those attempting to affect what types of industries employ American workers, e.g., subsidizing certain sectors, strengthening trade barriers. Indeed, the decline of jobs in manufacturing represents the confluence of forces well beyond the control of government, forces such as the evolution of technology, the decline of transportation costs and the growing integration of markets around the world.

Therefore, falling wages and the problems associated with workers who have been displaced from this sector are probably most effectively addressed through programs that provide workers with job skills that the American economy now demands, as discussed in the report. Moreover, by augmenting the human capital of all workers in the United States, the ability of individuals to make the transition from one line of work to another is enhanced, with relatively modest losses in earnings.