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Wage Inequality in the Era of the Knowledge Economy

Adam Rust's picture

Posted September 14, 2010

We know that the new economy is rewarding workers with more education, but it turns out that there is a crowd effect: highly educated workers earn more when they are living and working in areas with lots of other smart workers.

College graduates make more money in a labor market where there are more college graduates. Skilled workers create demand for other skilled workers. "The presence of a larger number of college graduates might put downward pressure on wages for all college graduates," says Julie Hotchkiss, a research analyst from the Atlanta Fed. "As it turns out, college graduates tend to benefit in terms of earnings

from a concentration of college graduates in the same labor market. There seems to be a complentarity of skills that  generate higher earnings...this is not the case for lesser-educated workers."

A new study by the Federal Reserve says that  new technology drives much of the gap. Businesses have seen the value of investing in their information systems for a long time, and it is apparently something that is become more and more important. The expenditure that firms made on computer software increased by more than 220 percent during each of the last two decades, a rate of increase that doubled the rate of the growth in the 1970s.

One problem is that getting more smart workers is easier said than done. The supply of knowledge workers doesn't adjust to the new normal, though.  The demand that these knowledge economy employees create is not filled by new supply of skilled workers. Our universities aren't putting out more skilled workers, and our immigration policies curb the ability of firms to pull in new workers from other countries.

There are plenty of numbers out there that document the new division in wages. Skilled workers make 40 percent more, adjusting for inflation, than they did in 1963, while unskilled labor actually have seen their wages decline. Most of the change is driven by a stagnation of wages for low-skill workers.

It hasn't always been this way. In the 20s, technology changes lifted the relative earnings power of lower-skilled workers. Mass production techniques eliminated the need for highly skilled craftsman. By contrast, unskilled workers were suddenly able to find solid jobs at profitable firms.

The lack of wage growth for low-skill workers is often used as evidence to support claims that unionization undermines economic growth. The Fed noted that more unionization did coincide with lower rates of wage growth, but that co-incidence was mainly factored by the fact that unionized workers are more likely to have the lower skill sets that have generally been undermined by the new labor market needs. In other words, factory workers have had a hard road before them, and the fact that many of them are unionized is somewhat irrelevant to what's going on more broadly. Union workers have less wage power, but that is because of the bias in the business sectors that they are more likely to be working in.

One implication of this research  would be to focus on attracting the high-skill workers whose presence spills over into enhancing the wages of those around them. Unfortunately, that is easier said than done. There are clusters of high-knowledge areas: Silicon Valley, Austin, Boston, Raleigh-Durham (bio-tech), Seattle (software), New York (finance), Kansas City (ag tech), and San Francisco - but those are few compared to the scores of Modestos, Orlandos, and Youngstowns. More than half of all venture capital firms are located in just three metro areas.