In recent decades, the overall proportion of 20- to 25- year-old men and women who attended college increased along with the education premium (increased pay for those with greater education and skills).When the returns from education—in this case the gain in income from going on to college—fell in the 1970s, the fraction of the population going to college also declined. Similarly, the rise in returns since 1980 has been accompanied by a significant rise in the fraction going to college. In addition, the increase in people pursuing higher education is found among all racial and ethnic groups and for men and women.

The trend toward larger gaps in earnings between those with only a high school diploma compared to college graduates has contributed significantly to the growth in overall earnings inequality. In recent years, the labor market has placed a greater emphasis on education, as seen in the growing salaries of those with MBA's, law degrees, and other advanced degrees. More generally, the pay premium for having a college degree versus stopping after high school increased from roughly 30 percent in 1980 to roughly 60 percent in recent years. The premium for having a graduate degree increased even more—from roughly 35 percent in 1980 to over 100 percent today.

In the recent study “Is the Increased Earnings Inequality Among Americans Bad?” University of Chicago Graduate School of Business professors Gary S. Becker and Kevin M. Murphy provide an economist�s perspective on the issue of income inequality

Becker and Murphy�s analysis of this issue hinges on “human capital ”—people�s investments in knowledge, skills, information, and health, all of which constitute long-lasting investments in themselves.

“Human capital is the foundation of the modern economy, ” says Becker. “The earnings gap is largely due to the fact that some people have more human capital than others in terms of education and training. ”

The authors suggest that the foundation of the growth in earnings inequality of Americans has mainly been beneficial and desirable.

“Economists focus on incentives and investments,” explains Murphy. “The rise in earnings inequality in the last several decades has been associated with a significant rise in the payoff of education. Individuals and society can take advantage of this payoff by increasing investments in human capital, particularly in the form of education.”

Origins of Income Inequality
It is not surprising that the demand for skilled workers has grown rapidly given technological developments, advances in biotechnology, and the shift in economic activity toward finance and professional services. Globalization has increased the demand for products and services from the United States and other nations produced by college graduates and other highly skilled employees. Globalization also has encouraged the shift to importing products that require relatively low-skilled labor from China and other low-wage countries instead of producing them domestically.

The growth in wage differences across education levels is only one aspect of the growth in income inequality. Income inequality also has increased within education groups, reflecting increased returns to occupation-specific knowledge, on-the-job training, and quality of schooling. As with education, higher returns will increase incentives to invest in these skills and lead to a higher rate of growth in productivity and wages.

The potential growth generated by the higher return on education extends to the economy as a whole. The growth in the education level of the population has been a significant source of growing wages, productivity, and living standards over the past century. The increase in the return on schooling over the past two decades enhances this opportunity.

Higher returns to education will accelerate growth in living standards as existing investments have a higher return and additional investments in education will be made in response to higher returns. Gains from higher returns will not be limited to Gross National Product (GNP) and other measures of economic activity.

Prior research has shown that individuals who have higher education not only earn more but also live longer, save a larger fraction of their permanent incomes, and invest more in their children. These characteristics do not offset income inequality due to inequality in education, but reinforce what earnings inequality contributes to widening inequality in overall welfare.

“More-educated people are better off in almost every dimension,” notes Becker. “The education process itself leads people away from more harmful activities and toward better habits.”

The potential to improve one's labor-market prospects through higher education is greater now than at any time in the past century. As alluded to earlier, this potential extends across gender and racial lines: the growth in returns for women has paralleled that for men for the past 25 years, and educational returns for African-Americans have increased as much or more than those for whites over the same period.

In addition, many more women than men are now enrolled as college students, and women have shifted toward higher earnings fields such as business, law, and medicine. The greater educational achievement of women versus men is particularly prominent among African-Americans and Latinos.

Reframing the Debate
“Changes in the economy such as technological changes and globalization cannot be undone,” says Murphy. “These changes increased the advantage of people with greater human capital.”

The key to addressing concerns about growing income inequality is designing the right policies and recognizing the connection between growing earnings inequality and investments in human capital.

There have generally been two types of policies proposed to reduce inequality. One approach is taxation to redistribute income to lower-earners. That approach reduces inequality, but doesn�t address the issue of what generated the rising inequality and the greater reward for people who have more education.

An alternative approach would narrow income inequality by increasing the number of educated workers, which would change supply and demand conditions. If there are a greater number of educated workers, this will push down wages at the high end of the job spectrum. Having a smaller number of less-educated people will push wages up for low-wage workers.

“In the process of narrowing earnings inequality through this second method, you take advantage of the high return of education, increase income for individuals, and increase the contribution to society as a whole, ” says Murphy.

“There is much to be done about income inequality, but the emphasis has to be getting people to pursue more education and training,” says Becker. “The gap between the haves and the have-nots is particularly evident in earnings, but education and skill are not God-given and can be affected through the right policies.”

Why aren�t more high school graduates pursuing college when the benefits are so apparent? Why did the fraction of American youth who dropped out of high school, especially African-American and Hispanic males, remain constant for the last 25 years?

Becker and Murphy suggest the answer is that many young people are poorly prepared for college. One underlying problem is the rise of single-parent households and the resulting low skill levels reached by children in broken families. The cognitive skills required for academic success tend to get developed at very early ages, while noncognitive skills such as study habits, getting to appointments on time, and attitudes toward work are fixed at later ages. High school dropouts appear to be seriously deficient in the noncognitive skills that would enable them to take advantage of the higher rates of return to education and other benefits of human capital.

“Taking advantage of the returns afforded by higher education today requires that you be prepared, and much of that preparation takes place at home, ” notes Murphy.

Improving the education system is one avenue for improvement, as is recognizing that success in school is tied to the home.

Increasing Opportunity
“Not everyone needs to pursue advanced degrees, but everyone has the talent to acquire more skills than they have, ” says Becker. “That�s the main dilemma we're facing as we move forward in the United States.”

The authors conclude that the forces raising earnings inequality in the United States were on the whole beneficial because they reflected higher returns to investment in education and other human capital, as well as physical capital.

Becker and Murphy suggest that instead of lamenting the increased earnings gap, attention should be focused on raising the fraction of American youth who complete high school and then pursue a college education.

The authors argue that it would be problematic if the focus remains on earnings inequality itself and Congress tries to interfere with this inequality rather than trying to efficiently increase the educational opportunities of those who are left behind. Raising taxes on higher earnings due to greater skills would greatly reduce the productivity of the world�s leading economy by discouraging investments in its most productive and precious form of capital—human capital.

“Is the Increased Earnings Inequality Among Americans Bad?”
Gary S. Becker and Kevin M. Murphy. The American. 2007.