American.com
Income inequality in China substantially widened, particularly between households in the city and the countryside, after China began its rapid rate of economic development around 1980. The average urban resident now makes 3.2 times as much as the average rural resident, and among city dwellers alone, the top 10 percent makes 9.2 times as much as the bottom 10 percent.[1] But at the same time that inequality rose, the number of Chinese who live in poverty fell—from 260 million in 1978 to 42 million in 1998.[2] Despite the widening gap in incomes, rapid economic development dramatically improved the lives of China’s poor.
Politicians and many others in the United States have recently grown concerned that earnings inequality has increased among Americans. But as the example of China—or India, for that matter—illustrates, the rise in inequality does not occur in a vacuum. In the case of China and India, the rise in inequality came along with an acceleration of economic growth that raised the standard of living for both the rich and the poor. In the United States, the rise in inequality accompanied a rise in the payoff to education and other skills. We believe that the rise in returns on investments in human capital is beneficial and desirable, and policies designed to deal with inequality must take account of its cause.
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The potential generated by higher returns to education extends from individuals to the economy as a whole. Growth in the education level of the population has been a significant source of rising wages, productivity, and living standards over the past century. Higher returns to education will accelerate growth in living standards as existing investments have a higher return, and additional investments in education will be made in response to the higher returns. Gains from the higher returns will not be limited to GDP and other measures of economic activity; education provides a wide range of benefits not captured in GDP, and these will grow more rapidly as well due to the additional investments in schooling.
The potential generated by higher returns to education extends from individuals to the economy as a whole. Growth in the education level of the population has been a significant source of rising wages, productivity, and living standards over the past century. Higher returns to education will accelerate growth in living standards as existing investments have a higher return, and additional investments in education will be made in response to the higher returns. Gains from the higher returns will not be limited to GDP and other measures of economic activity; education provides a wide range of benefits not captured in GDP, and these will grow more rapidly as well due to the additional investments in schooling.
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This brings us to our punch line. Should an increase in earnings inequality due primarily to higher rates of return on education and other skills be considered a favorable rather than an unfavorable development? We think so. Higher rates of return on capital are a sign of greater productivity in the economy, and that inference is fully applicable to human capital as well as to physical capital. The initial impact of higher returns to human capital is wider inequality in earnings (the same as the initial effect of higher returns on physical capital), but that impact becomes more muted and may be reversed over time as young men and women invest more in their human capital. (more)
