Changes in Relative Wages in the 1980s: Returns to Observed and Unobserved Skills and Black-White Wage Differentials

Abstract

During the 1980s, did the sharp increase in the college-high school wage differential represent a rise in the college premium, or a growth in the payoff to unmeasured "ability" or "skill"? Can the slowdown in black-white wage convergence or the widening black-white gap among young workers witnessed during the 1980s be explained by a rise in the return to pre-labor market factors correlated with race? In this study, we show that it is possible to use across-group variation in within-group wage variances from multiple periods to identify the change in the return to unobservable skill, within a relatively unrestrictive error-components model of wages. The identification does not require full specification of the time-series properties or the functional form of the errors. Male earnings data from the CPS show that there is useful variation in within-group wage variances -- enough to estimate a growth in the return to unobservable skill of about 10 to 20 percent during the 1980s. In our analysis, these magnitudes imply that even alter controlling for the effects of an increase in the payoff to unobservable skill, college-educated workers still gain substantially relative to high school-educated workers, while young black men still experience a significant wage decline relative to white men during the l980s.