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Determinants of Wage and Earnings Inequality in the United States

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  • Slavik, Ctirad
  • Yazici, Hakki

Abstract

The U.S. wage and earnings distributions display significantly higher levels of inequality today compared to the late 1960's. The aim of this paper is twofold. First, we want to assess to what extent the observed changes in inequality can be explained by a model that incorporates the technology-education race model of Tinbergen (1974) into a standard incomplete markets model that macroeconomists use to study inequality. Second, we want to use this model to decompose the changes in the skill premium and in overall inequality into four components: skill-biased technical change, increase in the relative supply of skilled workers, increase in residual wage volatility, and changes in tax policy. We construct an incomplete markets model with capital-skill complementarity in which the wage distribution responds endogenously to technological changes. That is, technological advancements - modeled as a decline in the price of equipments - increase the amount of equipments in the economy which increases the skill premium endogenously. We calibrate the deep parameters of the model to late 1960's U.S. economy and find that the model matches well the inequality measures in the data. We find that our model overestimates somewhat the changes in both the skill premium and overall measures of inequality between the 1960's and the 2000's. We then decompose the change in inequality into changes in technology, relative supply of skilled workers, residual wage risk, and taxes. In line with Tinbergen's technology-education race theory, we find that the skill premium is most significantly affected by the changes in technology and supply of skilled workers. We also identify a mechanism not previously analyzed in the literature: an increase in residual wage risk leads to higher precautionary savings and thus to higher levels of aggregate capital. Due to capital-skill complementarities in the production function, this leads to an increase in the skill premium and thus to a further increase in inequality.

Suggested Citation

  • Slavik, Ctirad & Yazici, Hakki, 2015. "Determinants of Wage and Earnings Inequality in the United States," VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113021, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc15:113021
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E25 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Aggregate Factor Income Distribution
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes

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