RETURNS TO HUMAN CAPITAL AND WAGE INEQUALITY: THE CASE OF TAIWAN

Abstract

(ProQuest: ... denotes formulae omitted.)1.INTRODUCTIONTwo recent Taiwan empirical studies reach different conclusions on the effect of return to education and wage inequality. Using Taiwan's Survey of Family Income and Expenditure for the 1978-1996 period, Lin and Orazem (2003, 2004) find that despite the government policy of rapid expansion of a number of higher education institutions since the mid 1980s, the returns to higher education and greater experience are increasing over time, which is mainly due to persistent shifts in relative demand toward skilled labor, i.e. skill-biased technical change. As a result, wage inequality and returns to college-educated workers have risen in Taiwan since 1980. Moreover, the rising share of women in the labor force helped amplify these trends. The stylized fact is that family income inequality in Taiwan has indeed been increasing since 1980 (as shown in Figure 1 of Lin and Orazem, 2004); however, individual wage inequality has actually been decreasing since 1980 despite the increase in the years of schooling as shown in Figure 1.1 Chen and Hsu (2001) also document a decreasing trend in wage differentials between skilled and unskilled workers since 1980 and argue that wage inequality has fallen because of decreasing returns to college-educated labor relative to other educational groups.The returns to human capital seem to play an important role in understanding Taiwan's wage inequality. But, how to reconcile the fact that returns to higher education has an increasing trend while the wage inequality reveals a declining tendency, a phenomenon that contradicted to existing literature?Empirical studies have shown that rates of returns on human capital are around 15%-20% (see, for example, Heckman, 2003). Cross-country studies have also presented that human capital is a critical factor in enhancing productivity, hence affecting a country's long-run growth (for example, Behanbib and Sprigel, 1994). Human capital investment contains the access to new information and knowledge (Thomas et al., 1991) or capability to absorb new information (Schultz, 1975), which in turn enhances productivity. Aside from formal education, which is the major channel for human capital investment, Heckman, Lochner, and Taber (1998) find that about one-third to half of all skill acquisitions are from after school on-the-job training. Education and on-the-job training apparently increase people's productivity and hence the output of the economy. Over time, improvement in labor quality together with economic development also raises workers' wages.As human capital enhances productivity and hence wages, what is the likely relationship between returns to human capital and wage inequality? Experiences from advanced countries show that human capital investment usually increases the wages of skilled workers and thus widens the wage inequality as the countries develop, see e.g., Kats and Murphy (1992) and Autor, Katz, and Kearney (2008). Pereira and Martins (2000) investigate fifteen European countries during a period ranging between 1980 and 1995, finding that in most countries (except Germany and Greece) the dispersion in earnings increases with educational levels suggesting a positive interaction between schooling and ability with respect to earnings. Hartog, Pereira, and Vieira (2001) examine the evolution of the returns to education in Portugal over the 1980s and early 1990s, also presenting that wage inequality expanded in Portugal over the 1980s and the returns to education had an important role in this process. Saavedra (2001) studies three Latin American countries, Argentina, Brazil, and Costa Rica, and finds that wage differentials arising from education increased in Costa Rica while the relative premium to education fell in Argentina and Brazil. Looking at long-run changes of the U.S. wage structure, Goldin and Kats (2007) conclude that wage inequality was mainly driven by educational wage differentials. …