9.1.5Supply Determinants of Inequality

Topel (1997) focused on the supply-side determinants of wage inequality. First, he noticed that inequality seems more important in the United States than in any other country. For instance, in 1990 U.S. households at the highest decile of the wage distribution had disposable income 6.0 times higher than those at the lower decile. The comparable multiples were 4 and 3.8 in Canada and in the United Kingdom, respectively. These differences in the levels of inequality between countries were not as important in the 1960s. In the United States, the increase in inequality is partly due to a fall of 20% in the real wages of men at the bottom decile since1970. According to Topel, increasing inequality has also been driven by a steady increase in demand for skilled labor, which has outrun the increasing supply of such labor. Topel considers that a “solution” to this problem may be to increase the supply of educated workers (human capital) in order to match up supply and demand for skilled labor.

Topel then evaluated the impact of changes in the supply of skills on wage differentials and inequality. The first aspect is that certain changes in labor supply, such as increasing immigration and female labor supply, are alleged to exacerbate earning inequalities. A second reason to study the impact of labor supply on relative wages is to evaluate the likelihood that human capital investment will mitigate rising inequality. Evidence shows that the main effects would be among relatively high-wage workers, and human capital will probably not raise low-skill wages. The answers depends mainly on how well different skill groups substitute to one another.

Topel concluded that rising wage inequality is one of the most important social changes in modern history. If this change is demand-driven, supply-side factors might have also raised inequality, although existing research is not conclusive. Furthermore, there is hope that investment in human capital will reduce inequality. As the author put it:

‘The increase in return to college education has encouraged more young people to go to college, but there is a myriad of skills demanded in the labor market (elementary education, on-the-job training). Still, college educated labor will have its main impact on the upper end of the wage distribution, when social pathologies of inequality are actually at the lower end. ’