A reader in South Bend recently wrote a very insightful letter about this column.  In it he argued that attention to growing wage inequality in the country should be part of the economic discussion.   He is right – and given the proximity of the presidential election we are all going to hear plenty about it.  Here’s a bit of economic analysis of the situation.  

By itself income data can tell us a very misleading story.  The United States, unlike most other developed nations, enjoys significant income variability over an individual life cycle.  So, a snapshot across one year tells us more about the size of age groups in the country than our economic wellbeing.  However, there is strong evidence of a widening income gap between the wealthiest and poorest among us.  Further, the ability to jump from poverty to riches may be weaker now than in recent generations.  That motivates a discussion of the good and bad of income inequality.   

First, the belief that there should be no income gap between individuals is childish.  The market forces that make income differentials are ultimately what motivate our highly successful economy.  The pursuit of a higher salary needs no apology.  Some readers might still find this unconvincing, but I ask – does anyone really believe we’d have the number of doctors we currently enjoy if they were paid the same as a short haul truck driver?  

Embracing the good that income differentials provide the U.S. economy does not erase the badness of poverty.  Before talking about policy, understanding why the differentials exist is critical.   

There are many small causes for inequality in America.  These include immigration and a growing elderly (both groups make less money than average).  But, the largest and fastest growing source of inequality is due to the supply and demand of educated workers in the United States.  Here’s how it works.  

According to research by two Harvard economists, Claudia Goldin and Lawrence Katz, demand for college educated workers has grown over the past half century, but really exploded in the 1980s.  The cause is tough to pin down, but they attribute the demand growth to the computer revolution and other workplace factors.  

Goldin and Katz also looked at the supply side of the problem.  They found that the burst of public education and the growth in skills it brought narrowed the wage gap throughout the 20^thCentury.  But, by the 1980s the relative quality of high school education (which has stalled for 35 years) combined with slowing growth in college educated workers strangled the supply of high skilled workers.  

As any introductory economics student knows, the combination of lower supply and greater demand leads to a price increase. Inevitably, the wage premium for a high school diploma doubled in 50 years and that for a college degree rose by 60 percent.    

Education then, is perhaps the central key to altering the growing income gap between rich and poor.  Not surprisingly, this is a widely unpopular conclusion, for there’s no easy fix, and widespread blame.  The effects are not spread equally across ethnic groups or regions and many easy fixes could well exacerbate the situation.    

One thing is certain, the farther we get from confronting this truth, the harder the fix.