Abstract
Abstract The skill premium has increased significantly in the United States in the last five decades. During the same period, individual wage risk has also increased. This paper proposes a mechanism through which a rise in wage risk increases the skill premium. Intuitively, a rise in uninsured wage risk increases precautionary savings, thereby boosting capital accumulation, which increases the skill premium due to capital-skill complementarity. Using a quantitative macroeconomic model, we find that the rise in wage risk observed between 1967 and 2010 increases the skill premium significantly. This finding is robust across a variety of model specifications.
Highlights
The substantial increase in the wages of college graduates relative to those without college education, the skill premium, is one of the most notable inequality trends observed in the United States in recent decades
We find that the rise in wage risk alone increases the skill premium to 1.70, an increase of 18 percentage
The main purpose of this section is to evaluate the quantitative implications of the rise in residual wage risk for the skill premium using our model
Summary
The substantial increase in the wages of college graduates relative to those without college education, the skill premium, is one of the most notable inequality trends observed in the United States in recent decades. Another important finding that has been documented by Gottschalk and Moffitt (1994), Heathcote, Storesletten, and Violante (2010), Gottschalk and Moffitt (2012) and Hong, Seok, and You (2017), among others, is that U.S workers face a considerably higher level of individual wage risk than in the past. We propose a mechanism through which a rise in individual wage risk leads to an increase in the skill premium and shows that this mechanism can be quantitatively significant. The rise in the capital stock increases the skill premium due to capital-skill complementarity
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