BFI NewsMay 28, 2015

Outpacing Technology with Human Capital to Get Ahead

Robert Topel explains why returns on education are on the rise, and how it helps workers weather technological advancements.

A 2014 report by the AFL-CIO stated that in 2013, American CEOs were paid an average of $11.7 million per year. In his recent high-profile boxing match, Floyd Mayweather earned approximately $120 million for a single night’s work. These are high-profile examples of the growing income inequality that has sparked protests in cities across the US, political dialogue, and academic debates.

Robert Topel, the Isidore Brown and Gladys J. Brown Distinguished Service Professor at the University of Chicago Booth School of Business, explored the sources of this income inequality in a Becker Brown Bag lecture to Chicago Booth MBA students. Because wages are tied to growth and productivity, he focused on research findings that interrogate the the correlation between technology advancements and human capital investment that fuel economic growth.

Topel’s recent research with institute co-chair Kevin Murphy illustrates that there indeed is a growing wage gap between the top and bottom percentile of wage earners. He used findings from that work to explain how human capital and skill acquisition influence inequality. He and Murphy documented the change in income for skilled and unskilled workers between 1962 and 2012, showing much stronger growth in the earnings of skilled workers—a trend that accelerated in 1980.

“Technology improves over time and that’s what raises output,” Topel explained. “It favors skilled labor relative to unskilled labor.” For instance, Mayweather’s huge payday was made possible because television networks can charge viewers for subscriptions to boxing matches and exclude others, enabling higher returns for athletes. Computers are the primary technological tools for skilled laborers, extending this skills-based bias in technology to fields that favor those with college degrees.

According to Topel’s data, college graduates earned a 20 percent premium in weekly wages compared to high school graduates in 1980; that premium increased to over 60 percent by 2012. Men and women in the top decile of wage earners received more than double the income compared to those in the bottom half. And for those in the bottom 10 percent, wages remained relatively stagnant.

Workers saw evidence of these returns to education and went to college in higher numbers, Topel said, and that pattern is self-reinforcing. The skilled invest more in themselves because the returns are higher,” Topel said, “That tends to exacerbate inequality because they have more human capital than they otherwise would have … the more skills I have, the greater the returns are to using them intensively. And the more intensively I use them, the more skills I want to get.”

The investment in human capital starts early at home and continues over generations of families; the increasing returns on education enables those with more education to invest more resources into their own children’s educations. Quoting Jim Heckman, Topel remarked, “Children in affluent homes are bathed in cognitive and financial resources that effectively reduce their costs of acquiring human capital.” Educated parents strive to raise their children as “little bundles of human capital,” and the children themselves do the same.

Over much of the 20th century, the supply of people going to college kept up with the demand for skilled workers, and that was enough to to limit inequality. Wage growth for skilled workers actually declined a bit in the early 1970s, partly because the uptick in the number of men enrolling in college to avoid the draft during the Vietnam war flooded labor markets.

By the 1980s, with increased computerization and other technological advances, demand for educated workers grew faster than the supply and boosted wages.

Given that the data implies that skilled laborers have greater rates of returns than unskilled laborers, is the answer to narrowing the wage gap simply encouraging more people to pursue post-secondary education? Not quite,Topel said. “A lot of those families are just not prepared to make their kids into [skilled laborers]. It’s not as simple as ‘I’m going to take the kid out of the household and put them in school.’ There are a lot more inputs involved.”

Poor preparation for college seems to be a critical issue—particularly for men, who by Topel’s account of high school graduation data, are being outpaced by women in all subject areas, including fields like math and science often considered to be male-dominated. Male college enrollment has stalled, while the number of women attending college is still on the rise, and data shows women are coming out of high school better prepared to complete a college degree.

It is increasingly difficult for unskilled laborers to overcome the vast differences in early preparation for college and obtain financial and intellectual resources they need for upward mobility. Topel suggested that we may have exhausted the extensive margin of our domestic labor supply. “Maybe we’ve reached part of talent distribution where supply is just really inelastic; there’s just not that many people we can pull in,” he observed.

One potential policy response sometimes pursued in Europe is to use taxes or wage controls to compress wage distribution and increase equality. The danger there is that reducing the return to education means fewer people will invest in necessary tutelage. Skills-biased immigration reform and education reform is an obvious option, but it takes decades to enhance family environments and educational systems to train up the skilled labor force we need.

“Inequality is the symptom,” Topel concluded. “It’s not the disease; the disease is the relative scarcity of skills compared to what we had in the past. Solutions that seek to treat the symptom rather than the disease are likely to make the underlying disease worse, which makes skills even more scarce.”

—Fareine Suarez