Occupational Earnings, Compensating Differentials, and Human Capital: An Empirical Study

Abstract

This paper examines the empirical significance of the principle of compensating differentials for the occupational distribution of earnings in Canada. The estimated earnings equation relates differentials in earnings to differences in human capital investments of workers, training requirements, and other non-pecuniary characteristics of occupational employments. The evidence suggests that wage differentials are primarily 'equalizing differentials': workers receive higher pay in compensation for their higher schooling and work experience and for undertaking jobs that are risky, insecure, and require higher levels of general educational development and specific vocational preparation. The evidence also confirms the findings of hedonic wage equations that returns to schooling and experience may be biased when occupational requirements are not controlled. Salaires dans diverses occupations, diffrrentiels compensatoires, et capital humain: une etude empirique. Ce memoire examine la signification empirique du principe des diff6rentiels compensatoires pour expliquer l'eventail des salaires selon les occupations au Canada. Une equation des gains estimes etablit la relation entre les salaires et les differences dans les investissements en capital humain des travailleurs, la longueur de la periode d'apprentissage necessaire, et les autres avantages non-pecuniers attaches 'a une occupation. Les resultats suggerent que les differentiels de salaire sont d'abord et avant tout des diff6rentiels qui vont dans le sens de l'egalisation: les travailleurs reqoivent un salaire plus eleve en compensation pour le niveau d'experience et d'6education plus eleve qui est necessaire, et pour des travaux plus dangereux, moins stables et requerant des niveaux eleves d'instruction et une preparation particuliere. Les resultats confirment aussi les resultats derives d'equations de salaire de type hedonique indiquant que les rendements sur l'investissement en instruction et en experience peuvent etre fausses si on ne standardise pas les exigences des differentes occupations. The principle of compensating differentials outlined by Adam Smith in The Wealth of Nations is one of the many ideas of classical economists that have become a 'common place of economics. '1 The idea that differences in pecuniary wages are required to The authors wish to thank Steve Kaliski, Mike Abbott, and the Editor and anonymous referees for their helpful comments and suggestions. The financial assistance from Labour Canada on the initial phases of this study is gratefully acknowledged. 1 See Rees (1975) and McNulty (1980). According to Rees, 'Of the many ideas of Adam Smith that have stood the test of time, few have weathered better or are still more relevant than the idea of compensating wage differentials ... it would be hard to imagine a theory of relative wages that did not Canadian Journal of Economics / Revue canadienne d'Economique, XV, No. 3 August / aoet 1982. Printed in Canada / Imprimd au Canada 0008-4085 / 82 / 0000-0442 $01.50 (? 1982 Canadian Economics Association This content downloaded from 157.55.39.27 on Wed, 07 Sep 2016 06:38:18 UTC All use subject to http://about.jstor.org/terms Occupational earnings, compensating differentials / 443 compensate for the non-pecuniary advantages and disadvantages of different employments has remained in its original form for over two hundred years as an established analytical framework for the analysis of wage differentials. In recent years the principle of compensating differentials has sparked considerable theoretical and empirical interest in earnings distributions and their relationship with worker and job attributes. On the theoretical side the compensating principle has inspired the development of two major applied and policy-oriented economic models, the human capital theory and the recent hedonic wage function approach; while the human capital model emphasizes the significance of individual investment behaviour in the heterogeneity of labour incomes and singles out the length of training-formal schooling and informal training or work experience-as the principal compensating wage differential, the hedonic approach focuses on 'quality' variations in both worker and job attributes as an explanation for wage differences. Both models provide empirical conceptualization of the compensating differentials principle and have contributed significantly to a better understanding of labour market behaviour and wage determination processes. On the empirical side the availability of large data sets, incorporating information on both individual worker traits and job characteristics and requirements, and high-speed computers has helped in overcoming difficulties of measurement, thus facilitating empirical estimates of 'compensation' for non-wage characteristics. Consequently, in the past few years there has been a long line of empirical research in the United States relating wage differences to differences in worker and job characteristics.2 These studies have found considerable evidence of compensating wage differentials for jobs requiring additional years of training, together with positive average rates of return on the individual worker's human capital investments. The evidence on the direction and magnitude of compensating differentials for other characteristics, however, is so far inconclusive. Empirical work on these problems is practically non-existent in Canada, largely owing to the absence of appropriate data