Richard Freeman accurately describes
the recent rise in wage and income inequality in United States. He speculates
about its consequences, and proposes five policies to alleviate it.
Wages were no more unequally distributed in 1990 than in 1940.
They were even more unequally distributed during the Depression and in earlier
periods of economic stress. Our democratic society was preserved then, albeit
with strain. Democracy and the social order can survive at higher levels of
earnings inequality than those experienced in the 1960s.
What is different now is the trend. After 1940, inequality
was substantially reduced. The reduction came because the real wages of the
least skilled increased more rapidly than the real wages of the skilled, although
both grew substantially in the post-war period. A whole generation became
accustomed to this trend which started early in this century. One could make
a good living even if one dropped out of school.
What fuels the post-1980 rise in wage inequality is the absolute
decline in real wages for the unskilled caused by a shift in demand away from
them. Until recently, such a decline only occurred during depressions or severe
crises when wages of all workers decreased. Now, however, the wages of the
unskilled are declining when the wages of the skilled are rising. Expectations
about success in the labor market have dramatically changed for a whole generation
of unskilled workers. Standard measures of earnings inequality understate
the severity of the problem because they exclude nonearners. Among the least
skilled, nonemployment and lack of any earnings has substantially increased.
When Freeman and others write about the problem of inequality,
they are concerned about this phenomenon, not inequality per se, although
some of Freeman's proposals seem directed toward solving the problem of inequality
and not the problem of declining real wages. The principal issue is to raise
living standards at the bottom. Redistributive policies aimed at eliminating
inequality miss the point. Our current problem is not that some are doing
better than others, but rather the despair among the least-skilled, who have
become detached from the modern economy. If the trend continues, it will promote
participation in the social pathologies of crime, welfare, and illegitimacy.
In addressing the problem of the unskilled, it is important
to take a long view while at the same time recognizing the problems of social
dislocation caused by the new labor market. In general terms, Freeman is right
when he speculates that the most effective long-run policy is to target interventions
early in life. More specifically, all the available evidence points to the
great long-run value of raising the skill levels and motivation of the very
young. Research in psychology and economics indicates that skill begets skill;
early learning promotes later learning. Investment in the education and training
of the very young earns a far higher return than investment placed in a teenager
or middle age adult. John Donohue of Stanford Law School and Peter Siegelman
of Yale Law School have estimated that the benefits of reduced crime alone
more than pay for the costs of an enriched Head Start program targeted toward
With older workers, matters are more complicated. Policies
that improve skills can help, but my research and that of others demonstrates
that such policies are very costly, even if applied to unskilled and low-ability
youth in their late teens, and certainly if applied to older workers. The
economic return to education and training for these people is so low that
a more useful policy would be to subsidize their employment. Job subsidies
offer an attractive alternative to welfare: they promote employment, integrate
the unskilled into the economy, and provide them, their communities, and their
children with the dignity and social benefit of work. I have developed this
Subsidies can take many forms. The Earned Income Tax Credit
is one program that creates financial incentives for low-income persons to
work. Other subsidy programs would induce employers to hire low-skill workers
at high wages by compensating them for the gap between wages and productivity
of their unskilled workers. Targeting job subsidies too narrowly and at too
low a benefit level can backfire, however, and it is important to avoid stigmatization.
If subsidies are given only to very low-skill workers with severe motivation
problems, and the subsidy is not sufficiently large, research by Gary Burtless
of Brookings reveals that employers view the subsidy as a warning label and
do not hire subsidized workers.
In contrast, policies that reduce the demand for the unskilled,
like minimum wage laws or increases in union wage scales, are generally bad
ideas. They increase the wages of those who remain employed but at the same
time have the perverse effect of increasing inequality among the least skilled,
and reducing their employment.