Precautionary Demand for Education, Inequality, and Technological Progress

Abstract

Individuals choose to invest in general skills through education or technology-specific skills by working on the job. Technological progress, which occurs randomly across sectors, depreciates technology-specific skills - thus increasing the return to education and generating a precautionary element in the demand for education. Consistent with existing empirical evidence, the model predicts that the sources of inequality growth are different within educated and uneducated workers: increasing randomness is a primary source within uneducated workers, while inequality growth within educated workers is determined more by changes in the composition and return to ability. The model generates an endogenous evolution of inequality "within" and "between" groups that is consistent with the patterns and sources of inequality growth over the last few decades. The model also generates patterns of inequality and skill composition within industrial sectors - most notably, the well-known positive correlation between the rate of technological change and skill-upgrading within an industry. In addition, we empirically verify the "precautionary demand for education" by showing that individuals consider the income risk associated with being an uneducated worker when making their schooling decisions.

JEL Classification: J31, O11, O33, O40