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Understanding Wage Inequality: Ben-Porath Meets Skill-Biased Technical Change

  • Fatih Guvenen
  • Burhanettin Kuruscu

    ()

    (Economics University of Texas at Austin)

This paper introduces a tractable general equilibrium overlapping-generations model of human capital accumulation, and shows that it provides a consistent explanation of several key features of the evolution of the U.S. wage distribution from 1970 to 2000. The framework is based on the Ben-Porath (1967) model. The key feature of the model, and the only source of heterogeneity, is that individuals differ in their ability to accumulate human capital. To highlight the working of the model, we abstract from all kinds of idiosyncratic uncertainty that has been the focus of recent research. Thus, wage inequality only results from differences in human capital accumulation. The main thought experiment is the following. We calibrate the model to be consistent with the features of the wage distribution in 1970, and then consider the effect of skill-biased technical change, modeled as an increase in the returns to human capital after 1970. The model is both qualitatively and quantitatively consistent with: (i) a large increase in wage inequality but a much smaller rise in consumption inequality, which happens at the aggregate level as well as within each cohort (Krueger and Perri 2004; Blundell and Preston, 1998), (ii) a falling college-high school premium in the 70's followed by a strong rise starting in early 80's (Katz and Murphy 1992), (iii) stagnating median wages (and a slow-down in labor productivity) from mid-70's until mid-90's, (iv) the fact that the wage growth of a worker between 1965 and 1990 was almost linearly related to his position in the wage percentile distribution in 1965 (Juhn, Murphy and Pierce 1993), (v) the evolution of the 90-50 and 50-10 percentile differentials. We also show theoretically that several of these results are robust features of this model, as long as the heterogeneity in ability is sufficiently large.

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File URL: http://repec.org/sed2006/up.28842.1140064444.pdf
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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 881.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:881
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. James Heckman & Lance Lochner & Christopher Taber, 1998. "Explaining Rising Wage Inequality: Explanations With A Dynamic General Equilibrium Model of Labor Earnings With Heterogeneous Agents," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(1), pages 1-58, January.
  2. Iourii Manovskii & Gueorgui Kambourov, 2005. "Accounting for the Changing Life-Cycle Profile of Earnings," 2005 Meeting Papers 231, Society for Economic Dynamics.
  3. Lawrence F. Katz & Kevin M. Murphy, 1992. "Changes in Relative Wages, 1963–1987: Supply and Demand Factors," The Quarterly Journal of Economics, Oxford University Press, vol. 107(1), pages 35-78.
  4. Gourinchas, P.O. & Parker, J.A., 1997. "Consumption Over the Life Cycle," Working papers 9722, Wisconsin Madison - Social Systems.
  5. Costas Meghir & Luigi Pistaferri, 2001. "Income variance dynamics and heterogenity," IFS Working Papers W01/07, Institute for Fiscal Studies.
  6. Bound, John & Johnson, George, 1992. "Changes in the Structure of Wages in the 1980's: An Evaluation of Alternative Explanations," American Economic Review, American Economic Association, vol. 82(3), pages 371-92, June.
  7. David Card & Thomas Lemieux, 2001. "Can Falling Supply Explain the Rising Return to College for Younger Men? A Cohort-Based Analysis," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 705-746.
  8. David Card & John E. DiNardo, 2002. "Skill-Biased Technological Change and Rising Wage Inequality: Some Problems and Puzzles," Journal of Labor Economics, University of Chicago Press, vol. 20(4), pages 733-783, October.
  9. Juhn, Chinhui & Murphy, Kevin M & Pierce, Brooks, 1993. "Wage Inequality and the Rise in Returns to Skill," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 410-42, June.
  10. Paul Beaudry & David A. Green, 2003. "Wages and Employment in the United States and Germany: What Explains the Differences?," American Economic Review, American Economic Association, vol. 93(3), pages 573-602, June.
  11. Daron Acemoglu, 1998. "Why Do New Technologies Complement Skills? Directed Technical Change and Wage Inequality," The Quarterly Journal of Economics, Oxford University Press, vol. 113(4), pages 1055-1089.
  12. Daron Acemoglu, 2000. "Technical Change, Inequality, and the Labor Market," NBER Working Papers 7800, National Bureau of Economic Research, Inc.
  13. Fatih Guvenen, 2009. "An Empirical Investigation of Labor Income Processes," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 58-79, January.
  14. Richard Blundell & Ian Preston, 1997. "Consumption, inequality and income uncertainty," IFS Working Papers W97/15, Institute for Fiscal Studies.
  15. Lillard, Lee A & Weiss, Yoram, 1979. "Components of Variation in Panel Earnings Data: American Scientists, 1960-70," Econometrica, Econometric Society, vol. 47(2), pages 437-54, March.
  16. Baker, Michael, 1997. "Growth-Rate Heterogeneity and the Covariance Structure of Life-Cycle Earnings," Journal of Labor Economics, University of Chicago Press, vol. 15(2), pages 338-75, April.
  17. Heckman, James J, 1976. "A Life-Cycle Model of Earnings, Learning, and Consumption," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages S11-44, August.
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