Changes in Wealth Inequality between College and High-School Graduates: Life-Cycle Model and Reality

This paper analyzes the changes in wealth inequality between college graduates and high-school graduates between 1989 and 2007. The college/high-school net worth gap first narrowed from 1989 to 1995 but then increased thereafter. The wealth gap between the two groups reflects the earnings gap as the evolution in the wealth gap follows the changes in the college premium in income during the sample period. Some “stylized facts” about earnings inequality are also found in the dynamics of wealth inequality ---within-group inequality increased substantially, and an increase in residual dispersion accounts for a considerable fraction in widening wealth inequality. However, a simple life-cycle model based on income differentials cannot account for the large swings of the wealth gap between the two groups. The two groups differ substantially in terms of demographic characteristics and attitudes towards saving, which account for a considerable part of the wealth gap. The differences of the two groups manifest in divergent portfolio holdings, particularly stockownership and homeownership. Dynamics of the wealth gap reflect changing patterns of homeownership, housing wealth, and stockholding. The narrowing of the wealth gap between 1989 and 1995 coincided with rising homeownership of high-school graduates, while the widening of the gap thereafter corresponded to the stagnant growth of homeownership of this group versus college graduates whose stock investment and homeownership rate increased considerably. College graduates invested heavily in owner-occupied housing by taking on larger mortgages and shifted their asset composition from financial assets to housing in 2004, the pattern followed by high-school graduates in 2007. As a result, American households, although they have become wealthier than before, have become vulnerable to income shocks as they hold more wealth in illiquid forms and have a larger debt. JEL Classification Codes: D31, D91, E21, G11