Seeing the good in inequality

New research suggests that whether rising inequality is considered good or bad depends on how it came about. An increase in earnings inequality due primarily to higher rates of return on education and other skills can be considered a favourable, rather than an unfavourable, development, a new study argues.

by Chicago Graduate School of Business
Last Updated: 23 Jul 2013

Chicago Graduate School of Business and University of Chicago professors Kevin M. Murphy and Gary S. Becker argue in a research paper that the debate around income inequality needs to be reframed around the idea of human capital and its increasing significance in the economy.

This trend is part of what is described as globalisation - the growing importance of professional and financial services in advanced economies like the US, and the shift of less skilled production jobs to emerging economies in Asia.

They see long-term benefits in the economic trend toward greater income differentials between those who leave school early and those who go on to seek college degrees and postgraduate qualifications. The income gap between high-school leavers and graduates has increased from around 30% to 60%, and has risen to from 35% to 100% between high-school leavers and those who continue studies to postgraduate level.

As economists, they argue that this rising premium for acquiring more education and skills acts as an incentive for individuals to raise their game and increase their marketable skills.

Rather than focus efforts on redistributing tax revenues from high earners to low earners, the economists suggest that policymakers should instead try to raise the proportion of young people who stay on in education. This would increase competition among the better educated and skilled professional workers and put downward pressure on wage growth, while a fall in the supply of unskilled or semi-skilled workers would push up wages in these groups. The overall impact, according to economic theory, would be a reduction in income inequality, at the same time as an increase in the overall educational level of the workforce. The benefits of this go beyond mere economics.

As the authors point out, 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 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 study then has to explain the stubborn refusal of many Americans, particularly those from Hispanic and African American communities, to respond to the incentives they describe. Their explanation is the low level of ‘non-cognitive' skills of children from one-parent families, who by the time they reach school-leaving age are poorly prepared for college life.

Improving the education system is one avenue for improvement, as is recognizing that success in school is tied to the home, say the authors. This in turn suggests greater support for single parent families or more intervention to improve the non-cognitve skills of children from these backgrounds.

One issue the authors do not answer is: if individuals and families have to bear the whole burden of the cost of their education, clearly market forces will eventually cause fewer to seek higher education as the premium attached to this kind of human capital falls, as the pool of educated workers increases competition for higher skilled work.

Their prescription for reducing income inequality, which in the US and in other liberal economies is at levels not seen in a century, also leaves aside other factors that improving educational opportunities cannot address: the growth in asset inequality.

Arguably, asset ownership is a greater determinant of life chances than education. The benefits of rising asset values to families as a result of unprecedented asset value growth over the last two decades is the other great cause of growing income inequality in the globalised economy. Education levels, from this perspective, are secondary rather than primary determinants of a person's overall welfare in an unequal economy.

Is the Increased Earnings Inequality Among Americans Bad?
Gary S. Becker and Kevin M. Murphy.
The American. 2007
Review by Joe Gill

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