Changes in relative wages in the 1980s: Returns to observed and unobserved skills and black-white wage differentials

We assess the potential contribution of a rise in the return to unmeasured productivity correlated with education and race to the dramatic increase in the college-high-school wage differential and the stagnation of black-white wage convergence during the 1980s. A relatively unrestricted error-components panel data model is used to estimate the rise in the unobserved skill premium. Identification of the model is based on across-group variation in changes in within-group log-wage variances over time. In the absence of credible instruments for education and race, we calibrate the impact of time-varying 'ability' biases under various assumptions on the extent of non-random sorting of ability. Both between-cohort and within-cohort changes are examined using earnings data on men from multiple Current Population Surveys. There is systematic variation in changes in within-group wage variances over time, suggesting about a 10-25% rise in the unobserved skill premium during the 1980s. In addition, there are noticeable differences across cohorts in changes in the college-high-school wage gap. However, the model estimates imply that the rise in the return to ability can account for at most 30-40% of the observed rise in the college premium for young workers. Similarly, young, well-educated black men experienced at least a 0.13 log point decline in wages relative to their white counterparts between 1979 and 1991.