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August 15, 1992

Federal Reserve Bank of Cleveland

The Recent Rise in the Value of
Education: Market Forces at Work
by Erica L. Groshen and Colin Drozdowski

An the past decade, higher levels of
schooling have become more financially
rewarding. Adjusted for inflation, the
earnings of college-educated workers
rose during the 1980s, while they declined for employees with a high-school
diploma or less. This development stands
in marked contrast to the 1970s, when
college-educated workers actually lost
ground relative to those with only a highschool degree.
The bipartisan support accorded to the
Higher Education Bill of 1992, which
expands access to college loans, and
the increasing interest in educational
reform recognize the growing economic
value of schooling and its importance
to our national future.
The wage premium received by educated
workers measures the current value their
employers place on education. Thus,
trends in that premium can be understood
by examining shifts in the relative supply
and demand for educated workers. This
Economic Commentary explores possible sources of the recent patterns of education's economic rewards in a market
framework and considers several of its
myriad implications.
• The Economic Return
to Schooling
How do we know that the value of, or
economic return to, education is positive
and has increased? One approach is to examine over time the median income of
people with different levels of schooling.
In figure 1, we plot these values for

ISSN 0428-1276

young people in 1980 and 1987. For
both years, inflation-adjusted income
rose with amount of schooling, a strong
indication of education's importance in
the labor market.
To see whether that value has increased,
we compare median income changes of
college-educated people to those of persons with high-school degrees or less. Between 1980 and 1987, the average annual
income of young high-school dropouts
(workers with 9 to 11 years of education)
fell 15 percent, while the income of
young college graduates rose 7 percent.
Thus, the income gap between collegeand high-school-educated workers was
larger in 1987 than in 1980; schooling
became more valuable.
But what is the long-term pattern, considering that a college degree represented
the educational dividing line between
income-gainers and income-losers in the
past decade? Figure 2 tracks the ratio of
the median income of college-educated
people to that of high-school graduates
(or the relative wage premium of the
highly educated) from 1967 to 1987. The
ratio fell slightly throughout the 1970s,
but rose sharply after 1980. Other research indicates that the 1980s' phenomenon of a rising economic return to education not only is strong, but pervades all

The 1980s' phenomenon of a widening income gap between college graduates and less-educated workers can
be understood by examining market
trends. The recent growth in the financial benefits of education reflects the failure of the relative supply of highly
educated workers to keep pace with
increasing demand for their skills. This
need has been fueled by foreign competition and by technological change that
favors more-skilled workers. Larger
schooling-based wage disparities are
likely to persist or to widen further unless educational attainment revives—a
trend that holds profound implications
not only for employers and employees,
but more broadly for our regional and
national prosperity.

• The Value of Education in a
Supply and Demand Framework
The income disparity between college
and high-school graduates depends on
the relative demand and supply for their
services. Thus, to understand the pattern
of the schooling premium shown in figure
2, we need a corresponding measure of
the "quantity" of educated labor in the
market. Figure 3 tracks such a measure—
the proportion of people with a college degree—from 1967 to 1990. The educational
attainment of young workers first climbed
steadily, then leveled off after 1976.
Because schooling takes time to acquire, only a certain amount of educated labor is available in the market at
any particular time. But what explains
supply shifts over time, such as those
shown in figure 3? School can be seen
as an investment made by individuals
(or by their parents or community) that
pays off during their working life.
Thus, higher expected benefits from
education, reductions in schooling
costs, or jumps in the number of highly
skilled immigrants all raise the share of
the labor force who have an education.
Using this information on supply and
premiums, figure 4 summarizes the
past two decades of changes in the
value of a college education by plotting
the quantity-premium combinations
for the end-years of the data (1967 and
1987) and around the turning point in
price (1980). This allows us to envision
the supply and demand curves that
determined each point. We draw vertical supply curves (shown as S67, Sgrj.
and Ss7) through each point to reflect
the fact that the relative quantity of
education cannot change quickly.
Next, through each point we draw a
downward-sloping demand curve for
education in labor (shown as Dg7, D80,
and D87). Employers' willingness to
pay more to educated workers is generally attributed to expected increases
in productivity. Some industries benefit
more than others from an educated

Thousands of 1987 dollars






Years of education



NOTE: Data are for persons age 25-34 with income.
SOURCE: U.S. Department of Commerce, Bureau of the Census.

work force, so employers differ in the
educational composition of their
employees. For any distribution of technologies, the lower the premium for
educated labor, the higher the average
schooling demanded by employers, as
shown in the negatively sloped demand
curves in figure 4. The demand curve
will shift outward (say, from D67 to Dso,
and then to D87) if technological changes
raise the relative productivity of educated
labor, or if product demand increases for
employers with technologies that benefit
most from educated workers.
Thus, explanations for changes in the
return to education can start by establishing whether shifts in supply or
demand were responsible. The constant
economic return to schooling from
1967 through 1980 can be explained
by simultaneous growth in the relative
supply and demand for educated labor,
which kept pace with each other. In
contrast, the rising education premium
of the 1980s is consistent with a fixed
relative supply of education, where
employers' growing demand for schooling translated directly into income
gains for educated workers.

• Sources of the Increasing Value
of Education
Analysts have offered two leading explanations for the rising demand for
education, and a wider range of explanations for why supply kept pace
during the 1970s only to stall during
the 1980s.
Demand Story I—Skill-biased Technological Change Recent technological advances may favor more-educated
workers. That is, although some innovations increase the productivity (and hence
the wages) of all workers equally, many
others benefit certain groups more than
others. "Skill-biased" changes raise the
efficiency of skilled workers more than
that of unskilled workers. For example,
introducing office phone-mail spares employees the need to check message boxes
and saves receptionists the time spent
answering calls, but requires the efforts
of a computer specialist for its setup and
maintenance. Thus, this innovation reduces the demand for receptionists, raises
the demand for computer specialists (who
are highly skilled), while on average making all those employed more productive.








1979 1981

Even if such biased technological change
lies at the root of the increased demand
for schooling, what is surprising is the
strength, persistence, and pervasiveness
of the bias toward skilled labor. Is there a
single kind of innovation that could
cause the return to schooling to grow dramatically for at least 20 years in all sectors of the economy?



The prime candidate for a single source
of skill-biased change is the computerization of the workplace. From 1984 to
1989, the share of businesses using
computers rose from 8 to 36 percent,
while the proportion of workers using
them (predominantly the collegeeducated) grew from 25 to 37 percent.
One study of the impact of computer
use on wage levels estimates that between one- and two-thirds of the increased return to schooling is directly
attributable to this source.3 Perhaps
workers need education to use computers
effectively, or to endow them with the
flexibility required for the rapid pace of
technical and product change found in
computerized workplaces.



But the influence of automation on the
workplace extends far beyond its direct
impact on computer users. Another
study finds that the ratio of high-tech to
total capital stock in manufacturing has
dramatically increased, from approximately 1 percent in 1976 to 26 percent
in 1986. High-tech capital includes
computers, instruments, and communications equipment, whose introduction
would clearly increase the relative demand for highly educated workers.'

1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989

Income ratioa









Percent with college degree



a. Ratio of median income of college graduates to median income of high-school graduates.
b. Share of young persons (age 25-34) with four or more years of college.
NOTE: Data for all figures are for persons age 25-34 with income.
SOURCE: U.S. Department of Commerce, Bureau of the Census.



The major argument against the skillbias explanation is that U.S. productivity gains actually slowed during the
1970s and 1980s. Could innovations
that so profoundly changed the structure of labor demand fail to boost overall productivity growth? Perhaps the
benefits of the innovations have not yet
been fully realized, or our measure of
productivity somehow misses their impact, or some independent factor has
depressed productivity.

Demand Story II—International Trade
The second demand-side theory (which
is not exclusive of the first) notes that
the U.S. labor force has been well educated compared to the rest of the world
for many years. In the absence of extensive foreign trade, the domestic demand for relatively scarce low-skilled
labor (and its products) supported wage
levels for uneducated workers that were
high by international standards. The
recent advent of lower trade barriers
and the expansion of trade could be expected to boost export-based demand
for the products created by our educated labor. Simultaneously, freer trade
would also expand low-cost imports of
the goods made by low-skilled labor
abroad, effectively increasing the competition faced by uneducated labor and
stifling their wages.
Although this explanation is compelling
in both its logic and its consistency
with the facts, most empirical research
has been unable to identify a large effect of trade on wages. The theory
either may be unimportant, or we may
be unable to detect it at work. The latter possibility arises because much of
our international trade involves exchanging products within the same industry, while empirical tests are limited
to inter-industry effects, relying on
trade data for broad industry aggregates. Therefore, it is possible that the
effect of international trade on the
wage structure will never be measured
with certainty.
Supply Factors—Costs and Expected
Benefits Why did the expansion of
educational attainment shown in figure 3
stall in the late 1970s? One would expect
that as the financial return to education
began to rise during the 1980s, a greater
number of people would have entered
and eventually graduated from college.
However, other factors, such as rising
real costs, may have influenced the relative supply of college graduates.

On the cost side, higher education became much more expensive in the past
decade. Expenses (tuition, fees, and
room and board charges) rose by two
times the rate of inflation in public institutions and by three times inflation
at private institutions. Meanwhile, the
average size of most federal student
grants and loans increased less than the
rate of inflation. Even if costs have not
risen as much as future benefits, higher
costs and lower subsidies mean that
more young high-school graduates may
face borrowing constraints for unsecured student loans.
On the benefit side, student deferments
from the military draft provided a powerful institutional incentive for college
enrollment that has since been eliminated. Alternatively, potential students
may have been dissuaded from attending
college by the falling financial return to
schooling witnessed during the 1970s
or by uncertainty about the permanence
of the current rewards. If so, attainment
may begin climbing again as news of
the increased financial benefits of a college degree spreads. Recent hikes in the
percentage of the population entering
and graduating from college may reflect such a response.
Finally, the number of low-skilled immigrants to the United States surged in
the 1980s. However, the estimated
direct effects of both legal and illegal
immigration on overall educational
levels are fairly small.
Other Explanations Additional theories, such as the impacts of declining
unionization and internal migration, have
been proposed, but have found only
limited empirical support. Similarly,
some analysts suggest that a decline in
the quality of a high-school education
could have widened the wage gap between college- and high-school-educated
workers. Leaving aside the question of
whether high schools could have
deteriorated so rapidly and uniformly
across the country, the fact that the return
to education also rose strongly for older
workers argues against this explanation.

• Conclusion and Implications
The weight of current research suggests that increasing financial benefits
from schooling throughout the 1980s
probably stem from steadily rising relative demand for educated labor, fueled
by skill-biased technological change
and foreign trade.
However, the contrast between the 1970s
(when the value of education fell) and the
1980s (when it rose) stems not from a
previous absence of these powerful
demand trends, but from the failure of the
relative supply of educated workers to
keep pace with increasing demand during
the past decade. Possible explanations for
the stagnant relative supply of labor
during the 1980s include spiraling real
costs of education, cuts in educational
subsidies, the end of Vietnam-era student
draft deferments, and increases in lowskilled immigration.
These findings have profound social
implications at many levels. Employers
have already faced widening internal
wage structures—a trend that is likely
to persist. In addition, large wage disparities based on schooling mean that
seniority alone will no longer be
enough to move low-wage workers
into more lucrative positions. Rather,
such promotions will hinge on the attainment of new skills, such as through
the use of in-house training or tuition
reimbursement plans. With or without
such programs, employers may find
that market factors will encourage them
to spin off some especially high- or
low-wage jobs to outside contractors,
subsidiaries, or other offices.
Second, these results tell us that the
prosperity of any group, region, or
country will depend on its commitment
to education. National discussions of
test scores and the level and efficacy of
educational subsidies have become
politically charged. On a regional
basis, this means that local income will
increasingly depend on local education
policy. For example, Ohio ranks 43rd
among states in spending on education
as a percentage of gross state product,
is 34th in the percentage of citizens
who graduated from high school (73
percent), and holds 39th place in the

percentage with some college attendance
(17 percent)—all facts that are worrisome
for Ohioans' future earnings. In all areas
of the country, as schooling grows more
valuable, the efficiency and effectiveness
of our educational system must be continually evaluated and improved in order
to maximize the benefits it bestows.
Finally, for individuals, prosperity will
be more fundamentally tied to their
educational achievements than ever
before. Young people need to understand that most of them will require
more schooling than their parents had,
just to attain the same standard of
living. And, since the quality and extent of education increasingly determine a child's fate, equal access to
high-caliber schooling more than ever
before will be the key to true equal opportunity, and an essential tool for
breaking the cycle of poverty.
Our findings suggest that the new wage
disparities between the poorly and highly educated are likely to persist or to
widen further unless educational attainment begins to rise again. Ultimately,
the future path of the educational
premium depends on reform of this industry and on whether the current cap
on schooling attainment is a short-run
phenomenon—easily lifted by spreading the news of the higher rewards of
education—or a long-run constraint.

• Footnotes
1. The analysis in this Economic Commentary uses a data series that ends in 1987, but
that allows us to make comparisons back to
1967, further than is possible by using other
series. To compare the trends reported here
with those in other data series, and to see
more current years, see Frank Levy and
Richard J. Murnane, "U.S. Earnings Levels
and Earnings Inequality: A Review of Recent
Trends and Proposed Explanations," Journal
of Economic Literature, 1992, forthcoming.
2. See Kevin M. Murphy and Finis Welch,
"The Role of International Trade in Wage Differentials," in Marvin H. Kosters, ed., Workers
and Their Wages: Changing Patterns in the
United States. Washington, D.C.: American
Enterprise Institute, 1991, pp. 39-69.
3. See Alan B. Krueger, "How Computers
Have Changed the Wage Structure: Evidence
from Microdata, 1984-1989," National
Bureau of Economic Research, Working
Paper No. 3858, October 1991.
4. See Ernst A. Berndt, Catherine J. Morrison, and Larry S. Rosenblum, "High-tech
Capital Formation and Labor Composition in
U.S. Manufacturing Industries: An
Exploratory Analysis," National Bureau of
Economic Research, Working Paper No.
4010, March 1992.
5. A higher proportion of college graduates
now take jobs in occupations where a college
degree is not required (see Daniel E. Hecker,
"Reconciling Conflicting Data on Jobs for
College Graduates," Monthly Labor Review,
vol. 115, no. 7 [July 19921, pp. 3-12). These
individuals are nonetheless paid a rising
premium for that degree, possibly indicating
changes in technical requirements within
those occupations.
6. The major exception is a study concluding
that international trade has increased the wages
of college-educated persons by 9 percent while
decreasing the wages of high-school graduates
by almost 3 percent. See Kevin M. Murphy
and Finis Welch, "The Role of International
Trade in Wage Differentials."
7. For college enrollment, see U.S. Department of Labor, Bureau of Labor Statistics,
News Release USDL 92-395, June 30, 1992.
For college graduation rates, see Kristina J.
Shelley, "The Future of Jobs for College
Graduates," Monthly Labor Review, vol. 115,
no. 7 (July 1992), pp. 13-21. On the basis of
admittedly speculative projections, Shelley

argues that supply increases may exceed
demand increases in the 1990s.
8. For an analysis of the impact of declining
unionization, see John Bound and George
Johnson, "Changes in the Structure of Wages
in the 1980s: An Evaluation of Alternative
Explanations," American Economic Review,
vol. 82, no. 3 (June 1992), pp. 371-92. The
internal migration hypothesis is refuted in
Erica L. Groshen, "Rising Inequality in a
Salary Survey: Another Piece of the Puzzle,"
Federal Reserve Bank of Cleveland, Working
Paper 9121, December 1991; and in Patricia
E. Beeson and Erica L. Groshen, "Components of City-Size Wage Differentials,
1973-1988," Federal Reserve Bank of
Cleveland, Economic Review, vol. 27, no. 4
(Quarter 4 1991), pp. 10-24.

Erica L. Groshen is an economist and Colin
Drozdowski is a research assistant at the Federal Resetye Bank of Cleveland. The authors
thank Patricia Beeson, Michael Bryan, and
Randall Ebertsfor helpful comments.
The views stated herein are those of the
authors and not necessarily those of the Federal Resen'e Bank of Cleveland or of the
Board of Governors of the Federal Reserve

Labor Conference Proceedings Now Available

Structural Changes in U.S. Labor Markets
The papers in this book, Structural
Changes in U.S. Labor Markets: Causes
and Consequences, edited by Randall W.
Eberts and Erica L. Groshen, were presented and discussed at a conference held
at the Federal Reserve Bank of Cleveland
in October 1989. The purpose of the conference was to identify and analyze recent
developments in personnel policy and
worker compensation practices, which
may have led to less wage inflation during
the 1980s and may continue to affect wage
behavior in the 1990s. Also considered
were possible consequences that these
changes might have on the formulation of
macroeconomic policy. The contributors
—academic and research economists in
labor economics—provide a comprehensive assessment of the current state of the
wage-setting process in the U.S. labor



by Randall W. Eberts and
Erica L. Groshen
International Trade and Money
Wage Growth in the 1980s
by Susan Vroman and Wayne Vroman
Comments: Louis Jacobson
Lump-Sum Payments and Wage
Moderation in the Union Sector
by Linda Bell and David Neumark
Comments: Ken Ross

Profit Sharing in the 1980s:
Disguised Wages or a Fundamentally
Different Form of Compensation?
by Douglas Kruse
Comments: Sharon P. Smith


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Structural Changes in U.S. Labor
Markets: Causes and Consequences
Randall W. Eberts and
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1991,351 pages,
hardcover, $39.95

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Indexation and Contract Length in
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by Mark Bils
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Gender Differences in Cyclical
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