The Increasing Value of Skills

The rich get richer, and the poor get poorer. Like many adages, this one is not always true, but recently it has been. Many studies have documented that the earning gap between workers with high skills and workers with low skills has increased over the past two decades.

Three decades ago a man on an average earned 40 per cent more with a college degree than without one; by 2008 this figure had risen to 80 per cent. For a woman, the reward for attending college rose from a 35 per cent increase in earnings to a 75 per cent increase. The incentive to stay in school is as great today as it has ever been.

Why has the gap in earnings between skilled and unskilled workers widened in recent years? The demand for skilled labour has risen over time relative to the demand for unskilled labour. The shift in demand has led to a corresponding change in wages, which in turn has led to greater inequality.

International trade has altered the relative demand for skilled and unskilled labour. In recent years, the amount of trade with other countries has increased substantially. As a percentage of total US production of goods and services, imports have risen from 5 per cent in 1970 to 16 per cent in 2003, and exports have risen from 5 per cent in 1970 to 10 per cent in 2003. Because unskilled labour is plentiful and cheap in many foreign countries, the United States tends to import goods produced with unskilled labour and export goods produced with skilled labour.

Changes in technology have altered the relative demand for skilled and unskilled labour. Consider, for instance, the introduction of computers. Computers raise the demand for skilled workers who can use the new machines and reduce the demand for the unskilled workers whose jobs are replaced by the computers. For example, many companies now rely more on computer databases, and less on filing cabinets, to keep business records. This change raises the demand for computer programmers and reduces the demand for filing clerks. Thus, as more firms use computers, the demand for skilled labour rises, and the demand for unskilled labour falls.

Increasing international trade and technological change may share responsibility for the increasing inequality we have observed in recent decades.

Ability, Effort and chance

Why do major league baseball players get paid more than minor league players? To a large extent, players in the major leagues earn more just because they have greater natural ability.

Natural ability is important for workers in all occupations. Because of heredity and upbringing people differ in their physical and mental attributes. Some people are strong, others weak. Some people are smart, others less so. Some people are outgoing, others awkward in social situations. These and many other personal characteristics determine how productive workers are and therefore play a role in determining the wages they learn.

Closely related to ability is effort. Some people work hard, others are lazy. It is not a surprise to find that those who work hard are more productive and earn higher wages. To some extent firms reward workers directly by paying people on the basis of what they produce. Salespeople, for instance are often paid a percentage of the sales they make. At other times, hard work is rewarded less directly in the form of a higher annual salary or a bonus.

Chance also plays a role in determining wages. If a person attended a trade school to learn how to repair televisions with vacuum tubes and then found that this skill was made obsolete by the invention of solid-state electronics, he or she would end up earning a low wage compared to others with similar years of training.

How important are ability, effort and chance in determining wages? It is hard to say because ability, effort and chance are difficult to measure. But indirect evidence suggests that they are very important. When labour economists study wages, they relate a worker’s wage to those variables that can be measured, such as years of schooling, years of experience, age and job characteristics. Although all of these measured variables affect a worker’s wage, they account for less than half of the variation in wages in our economy.

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