Education and Earnings

I thought I’d follow up on the FT story from earlier this week which noted that manufacturers claim that, even though they are laying off large numbers of workers (generally their less-skilled workers, they say), they are still very interested in hiring more highly educated workers such as technicians, engineers, and so forth.

Unsurprisingly (at least to economists), the aggregate data suggests that firms have put their money where their mouth is, in a big way. The phenomenon of substituting away from relatively low-skilled workers and toward relatively highly-skilled workers is widespread and massive. The chart below (source: Census) provides some measures of how more education is rewarded in the labor market. Clearly, getting more education means that you will be far more highly demanded by firms.

This reward to education has grown over time. For example, a Census Bureau summary of major economic trends in the US over the past half century reported that the median income of workers with at least a Bachelor’s degree was only 35% higher than those with only a HS diploma in 1963. By 1997 that premium had risen to 88%. And in 2003 the earnings gain from having at least 4 years of college was over 100% of a HS graduate’s earnings, according to the data cited above.

Perhaps most strikingly, this massive increase in the relative wages that firms pay for a college education has happened at the same time that the supply of college-educated workers has exploded. In the mid-1960s less than 10% of individuals in the US had a college degree, compared to about 20% in the mid-1980s and about 30% today. We can only conclude that the demand by firms for relatively well-educated workers has grown even more dramatically than the supply of such workers, which is to say, by a lot.

So clearly the payoff from greater education has risen substantially over the past half-century. Interestingly, this period also corresponds to a dramatic opening of the US economy to international trade and investment. One possible conclusion is thus that the forces of international economic integration have made education more valuable.

However, that is not the only possible reason for the increasing payoff to education. Technological change that benefits relatively well-educated workers at the expense of the less-skilled is the other most-cited explanation. You may be interested to note that there was a widespread and lively (okay, at times it was downright vicious) debate among economists during the early 1990s about which effect was larger. By the late 1990s I think it’s fair to say that most (though by no means all) economists were persuaded that technology played a bigger role than international trade in the relative gains that well-educated workers experienced over relatively less-educated workers.

Regardless, it seems beyond dispute that the way to succeed in the US economy today is to get more education. And with each passing year, this is only becoming increasingly the case.


UPDATE: Mark Thoma has more on this at Economist’s View.