How People Choose their College Helps to Explain Increasing Income Inequality among College-Educated Workers
High aptitude students are now more likely to end up surrounded by fellow high aptitude students and are more likely to be matched to demanding, costly educational programs.
In the last three decades, the incomes and wages of college-educated Americans have become more dispersed. In fact, inequality in their incomes has risen faster than income inequality among Americans overall. In Explaining Rising Income and Wage Inequality Among the College-Educated (NBER Working Paper No. 6873) , Caroline Hoxby and Bridget Terry break down the increase in income inequality among college-educated people into three components, two of which are conventional and one of which is new, and ask how much each factor has contributed.
The first component is the increasing diversity of college-goers' socio-economic backgrounds. Compared to the past, today's college students are diverse in terms of their race, ethnicity, nativity (whether they are immigrants), and parents' income. The second component is a rise in the return to aptitude, where aptitude includes both innate ability and academic achievement. The return to aptitude is not observed, but especially high increases in income among workers with high measured aptitude leads researchers like Hoxby and Terry to conclude that the return has risen. The third component, unique to Hoxby and Terry's work, is the change in the market structure of college education. Instead of choosing a nearby college or a relative's college (popular methods of choosing a college in the past), today's students choose colleges based on the match between their own aptitude and the colleges' educational resources and student bodies. High aptitude students are now more likely to end up surrounded by fellow high aptitude students and are more likely to be matched to demanding, costly educational programs. In short, aptitude differentials are falling within each college and are rising between colleges.
Hoxby and Terry suggest that increased "student sorting" of this type has occurred because information costs and mobility costs have decreased. ( Hoxby discusses this in NBER Working Paper No. 6323.) It is easier than before to get information about colleges' student bodies, the programs they offer, and sources of financial aid. Students can travel to a distant college at a lower cost, communicate with a distant home and friends for less money, and enjoy the same media and culture wherever they are.
Adding up the three factors, Hoxby and Terry estimate that about 15 percent of the growth in income and wage inequality among recipients of baccalaureate degrees is attributable to the increased diversity of their backgrounds. About 25 percent is explained by a rise in the return to aptitude and another 30 percent by changes in the market for higher education which have intensified student sorting. They note that previous researchers have exaggerated the importance of an increase in the return to aptitude because they did not take account of the changes in the market for higher education. The remaining 30 percent of the increase in inequality is hard to explain with the observed factors, though
-- David R. Francis