A Dynamic Equilibrium Model of the U . S . Wage Structure , 1968 - 1996

We develop an overlapping generations equilibrium model of the U.S. labor market, and fit it to PSID data from 1968-1996. Our main innovation is a much finer distinction among types of labor than in prior work – i.e., labor is differentiated by 1-digit occupation, education, gender and age, giving 160 types. This is important, as prior work has shown that: (i) wage and employment patterns over the sample period differ across occupation-education-gender-age groups in complex ways not captured by simpler models, and (ii) conclusions about effects of policies to increase human capital are very sensitive to the assumed substitution patterns across types. In our model the fraction of each youth cohort that attends college is determined in part by the college wage premium (as well as by parental background and tastes). The model provides a rather good fit to college attendance rates and occupational choices for narrowly defined types over the whole 29 year period. Hence, we use it to simulate the effect of tuition subsidies aimed at youth whose parents did not attend college. Our model implies that roughly 2/3 of the gain in their lifetime earnings resulting from increased college attendance is negated by equilibrium feedback effects, whereby increased supply of college labor lowers college wages. This is intermediate between earlier estimates by Heckman, Lochner and Taber (1998), who find that equilibrium effects almost eliminate earnings gains from tuition subsides, and by Lee (2005), who finds equilibrium effects are negligible. We also find that labor supply elasticities can be very misleading as guides to tax responses, due to equilibrium feedback effects on wages. Acknowledgements: This paper is heavily based on the first chapter of Mathew Johnson’s dissertation at Yale University. Conversations with John Roemer were instrumental in developing this project. We also thank Lance Lochner for providing very useful comments. Keane’s work on the project was supported by Australian Research Council grant FF0561843.