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Changes in the Return to Skills and the Variance of Unobserved Ability

Listed author(s):
  • Guido Matias Cortes

    ()

    (Department of Economics, University of Manchester, UK; The Rimini Centre for Economic Analysis, Italy)

  • Manuel Alejandro Hidalgo

    ()

    (Department of Economics, Universidad Pablo de Olavide, Spain)

Changes in the variance of wages among groups of workers with common observable characteristics are often interpreted as reflecting changes in the return to unobservable skills. This interpretation relies on the crucial and highly restrictive assumption that the variance of these unobservable skills remains constant over time. We propose a new identification strategy which relaxes this assumption using longitudinal data, and requires only two observations per individual. Using data from the Current Population Survey's Merged Outgoing Rotation Group sample over the period 1982-2012, we find that relaxing the assumption of constant within-group skill variance is crucial. Contrary to the conclusion drawn when this assumption is imposed, we find that the return to skills has fallen over our sample period, and that increases in within-group wage inequality are driven by increases in the dispersion of unobservable skills, particularly among college graduates.

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File URL: http://www.rcea.org/RePEc/pdf/wp15-45.pdf
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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 15-45.

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Date of creation: Dec 2015
Handle: RePEc:rim:rimwps:15-45
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  1. Richard Blundell & Howard Reed & Thomas M. Stoker, 2003. "Interpreting Aggregate Wage Growth: The Role of Labor Market Participation," American Economic Review, American Economic Association, vol. 93(4), pages 1114-1131, September.
  2. Chay, Kenneth Y. & Lee, David S., 2000. "Changes in relative wages in the 1980s Returns to observed and unobserved skills and black-white wage differentials," Journal of Econometrics, Elsevier, vol. 99(1), pages 1-38, November.
  3. 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.
  4. Lance Lochner & Youngki Shin, 2014. "Understanding Earnings Dynamics: Identifying and Estimating the Changing Roles of Unobserved Ability, Permanent and Transitory Shocks," NBER Working Papers 20068, National Bureau of Economic Research, Inc.
  5. Hendricks, Lutz & Schoellman, Todd, 2014. "Student abilities during the expansion of US education," Journal of Monetary Economics, Elsevier, vol. 63(C), pages 19-36.
  6. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2010. "The Macroeconomic Implications of Rising Wage Inequality in the United States," Journal of Political Economy, University of Chicago Press, vol. 118(4), pages 681-722, August.
  7. Blundell, Richard & Graber, Michael & Mogstad, Magne, 2015. "Labor income dynamics and the insurance from taxes, transfers, and the family," Journal of Public Economics, Elsevier, vol. 127(C), pages 58-73.
  8. Guido Matias Cortes, 2016. "Where Have the Middle-Wage Workers Gone? A Study of Polarization Using Panel Data," Journal of Labor Economics, University of Chicago Press, vol. 34(1), pages 63-105.
  9. Manuel Hidalgo-Perez & Benedetto Molinari, 2015. "Learning New Technology: The Polarization of the Wage Distribution," Working Paper Series 15-42, The Rimini Centre for Economic Analysis.
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