Changes in Relative Wages in the 1980s: Returns to Observed and Unobserved Skills and Black-White Wage Differentials


During the 1980s, did the sharp increase in the college-high school wage differential
represent a rise in the college premium, or a growth in the payoff to unmeasured "ability" or
"skill"? Can the slowdown in black-white wage convergence or the widening black-white gap
among young workers witnessed during the 1980s be explained by a rise in the return to pre-labor
market factors correlated with race? In this study, we show that it is possible to use across-group
variation in within-group wage variances from multiple periods to identify the change in the return
to unobservable skill, within a relatively unrestrictive error-components model of wages. The
identification does not require full specification of the time-series properties or the functional form
of the errors. Male earnings data from the CPS show that there is useful variation in within-group
wage variances -- enough to estimate a growth in the return to unobservable skill of about 10 to
20 percent during the 1980s. In our analysis, these magnitudes imply that even alter controlling for
the effects of an increase in the payoff to unobservable skill, college-educated workers still gain
substantially relative to high school-educated workers, while young black men still experience a
significant wage decline relative to white men during the l980s.

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