Hui He, University of Michigan

Abstract

The skill premium (average wage ratio between college and high school graduates) in the US increased in the 1950s and 1960s, decreased in the 1970s, and then has increased again dramatically since the early 1980s. What is the driving force behind this trend? Previous literature proposed several explanations such as skill-biased technological change (SBTC), fluctuations in the relative supply of skilled labor due to demographic change, and international trade. However, most research takes the relative supply of skilled labor as exogenously given. The current study finds a high correlation between the changes in skill premium and the college enrollment rate, which clearly suggests that there exists a dynamic link between the skill premium and the relative supply of skilled labor. To understand this dynamic connection, I develop an overlapping generations general equilibrium model with endogenous discrete schooling choice. The production technology has the feature of the capital-skill complementarity as in Krusell et al (2000). With this framework, I quantitatively examine the effects of two competing exogenous forces, investment-specific technological change (ISTC) as described in Greenwood et al (1997) and the demographic change expressed as "baby boom and baby bust", on the skill premium and enrollment rate. I find that in terms of the skill premium, demographic change dwarfed the ISTC before the late 1960s and contributed to the decline of skill premium in the 1970s. However, after the late 1970s, ISTC took over to drive the dramatic increase in skill premium. ISTC can also explain around 30% of the increases in the enrollment rate for the time period 1951-1991.