During the past four decades both between and within group wage inequality
increased significantly in many advanced economies and particularly in the
US. Three of the most well-documented facts concern the increase in the
education wage premium, the rise in the experience premium and the narrowing
gender wage gap.
Recent studies explain the rising education premium. However, the growing
experience premium still remains underexplored. The combination of private
employer learning, education signalling and credit constraints, provides a
microfounded justification for both patterns. After the 1965 Higher
Education Act, college loans extended and allowed less-privileged students
to acquire education. When financial constraints relax, talented individuals
can acquire education and leave the uneducated pool. This implies that the
eventual group of uneducated young workers becomes of lower average quality,
as most of the "rough diamonds" have now been plucked out of this group.
This explanation is consistent with US data from 1970's to 2000's,
indicating that the rise of the education and the experience premium
coincides with a fall in unskilled-inexperienced wages, while at the same
time skilled or experienced wages do not change much. The model accounts
also for the fact that the education premium increases more for
inexperienced workers, while the experience premium increases only for the
low-educated ones.
The introduction of gender-specific credit constraints, explains not only
the rise in the education and the experience premium but also the narrowing
gender wage gap, by allowing the cost of borrowing to become more similar
for the two genders recently compared to the past. This theory is coherent
with the US experience, as before the 1974 Equal Credit Opportunity Act
borrowing was much costlier for women, while recently credit extended and
allowed primarily gifted women who were previously liquidity constrained to
acquire skills, generating a better allocation of talent in education. This
explanation suggests that equalizing borrowing opportunities for men and
women, decreases inequality between genders, while it also increases
inequality within gender by boosting the wage gap between different
education and experience groups for both sexes.
This unified analysis, which brings theory closer to evidence, and explains
the evolution of wage inequality related to education, experience and
gender, highlights the potential conflict between equal opportunities and
substantial economic equality. At the same time it cautions policy makers
that desirable developments in market institutions, which allow broader
access to credit or decline the influence of gender discrimination in
borrowing, can in fact bear vicious consequences by increasing wage
inequality.
Researcher: Theodore Koutmeridis
Related CDMA Working Papers
1307
Theodore Koutmeridis The Market for "Rough Diamonds": Information, Finance and Wage Inequality
Media summary by the Royal Economic Society:
"Rough Diamonds": How Greater Equality of Opportunity Has Led to
Greater Inequality of Outcomes
