Chairman Ben Bernanke Delivers Remarks Before the Greater Omaha Chamber of Commerce

Although skill-biased technical change appears to be an important cause of the rise in earnings inequality, it does not provide a complete explanation for that trend. The hypothesis cannot explain, for example, why the sharp rise in investment in information technology in the 1990s was not accompanied by a higher rate of increase in wage inequality. Nor can it explain why the wages of workers in the middle of the distribution have grown more slowly in recent years than those of workers at the lower end of the distribution, even though, of the two groups, workers in the middle of the distribution are typically the better educated.

Another challenge for the hypothesis of skill-biased technical change, at least in its basic formulation, is to explain the especially large wage gains seen at the top of the distribution. A possible link between technological change and the substantial increases in the wages of the best-paid workers is that some advances, such as those that have swept the communications industry, may have contributed to the rise of so-called "superstars" -- a small number of the most-gifted individuals in each field who are now better able to apply their talents in what has increasingly become a global marketplace . For example, two decades ago, the highest-paid player for the Boston Red Sox baseball team (and in the American League), Jim Rice, earned (in inflation-adjusted terms) just over $3 million. In 2004, the highest-paid player on the Red Sox (and in all of major- league baseball) was Manny Ramirez, who received $22.5 million for the season. The number of fans who can fit into Fenway Park has not increased much since Jim Rice's day. But presumably the Red Sox owners believed that Ramirez's higher salary was justified by the increases in broadcast and merchandising revenues he might generate as a result of the confluence of new distribution channels (such as Internet-based broadcasts of games) and a larger and wealthier potential global audience. The earnings potentials of superstar entertainers, investment bankers, lawyers, and various other professionals have likewise risen sharply as technological innovations and globalization have helped them leverage their talents over a wider sphere.

The compensation of chief executive officers of corporations is often singled out for particular scrutiny. Some economists have argued that the observed increases in CEO pay packages can largely be justified by economic factors, such as changes in the relationship between the CEO and the firm that have led to shorter and less-secure tenures for CEOs and to a greater tendency to hire CEOs from outside the company. Others note that substantial increases in the size and scope of the largest corporations have raised the economic value of skilled corporate leadership. However, critics have responded that increases in CEO pay may have been amplified by poor corporate governance, including the substantial influence that some CEOs appear to have had over their own pay. This debate will no doubt continue.

Beyond the effects of technological change, the variety of economic forces grouped under the heading of "globalization" may also have been a factor in the rise in inequality, even as these forces have provided a major stimulus to economic growth and to living standards overall. Immigration -- the flow of people across borders -- is one aspect of the increased economic integration of the world economy. In recent decades, most immigrants to the United States have arrived with relatively low levels of skills. By itself, this pattern of immigration increases measured inequality because it leads to an increase in the relative size of the low-wage work force. Standard economic reasoning also suggests that the immigration of such workers should reduce the relative wages of less-skilled domestic workers. Empirical analyses of individual cities or regions have found some evidence that corroborates this hypothesis, although in most cases the effect appears to have been small. A typical finding is that an increase of 10 percent in the share of immigrants in a city reduces the wages of lower-skilled natives 1 percent or less. This somewhat muted effect of low-skilled immigration on local markets may reflect the adaptability of U.S. labor and product markets, which has allowed native workers and firms to adjust with relatively little displacement. However, studies that examine national data tend to find somewhat larger effects, with a 10 percent increase in the share of immigrants in the total population reducing the wages of low-skilled natives 3 percent to 5 percent.

International trade, another aspect of globalization, may also have differential effects on the economic well-being of U.S. workers even as it tends to raise real wages and incomes on average. For example, some empirical research suggests that, in the 1980s and 1990s, increased international trade reduced the profitability and hence the demand for labor in a number of industries that employed relatively more low-skilled workers. Of course, trade has increased the potential markets for other domestic industries, leading to higher demand and thus higher real wages for workers in those industries. A related development has been the outsourcing abroad of some types of services and production activities. Because labor markets are adaptable, outsourcing abroad does not ultimately affect aggregate employment, but it may affect the distribution of wages, depending on the skill content of the outsourced work. At least until recently, most such activity appears to have involved goods and services that use relatively more low-skilled labor, which (all else being equal) would tend through the workings of supply and demand to slow the growth of wages of domestic low-skilled workers relative to those with greater skills.

Unfortunately, much of the available empirical research on the influence of trade on earnings inequality dates from the 1980s and 1990s and thus does not address later developments. Whether studies of the more-recent period will reveal effects of trade on the distribution of earnings that differ from those observed earlier is to some degree an open question. Overall, I read the available evidence as favoring the view that the influence of globalization on inequality has been moderate and almost surely less important than the effects of skill-biased technological change.

Finally, changes in the institutions that have shaped the labor market over the past few decades may also have been associated with some increase in wage inequality. For example, unions tend to compress the dispersion of pay for jobs in the middle of the skill distribution. Thus, the decline in private-sector union membership over the post-World War II period -- particularly the sharp drop in the 1980s -- has been associated with an increased dispersion of pay among workers with intermediate levels of skill. The sources of the decline in union membership are much debated, and certainly long-run structural changes in the economy, such as the decline in manufacturing employment, have played a role. Whatever the precise mechanism through which lower rates of unionization affected the wage structure, the available research suggests that it can explain between 10 percent and 20 percent of the rise in wage inequality among men during the 1970s and 1980s.

Declines in the real value of the minimum wage, brought about by the combination of inflation and the fact that minimum wages are usually set in dollar terms, also affect the labor market. Some research suggests that this factor contributed to the relative decline in the wages of the least-skilled workers during the 1980s. Economists have also pointed out that, although higher minimum wages increase the wages of those who remain employed, they may also lead to reduced employment of low-skilled workers. Thus, the net influence of the minimum wage on earnings and income inequality, as opposed to the inequality of observed hourly wages, is ambiguous. In any case, the real value of the minimum wage, adjusted to include state minimum wages that are above the federal level, has been fairly flat in recent years, and so has the proportion of the labor force that is unionized. This suggests that these institutional factors have been less important sources of increasing wage inequality recently than they were in the 1970s and 1980s.

What, if anything, should policymakers do about the trend of increasing economic inequality? As I noted at the beginning of my remarks, answering this question inevitably involves some difficult value judgments that are beyond the realm of objective economic analysis -- judgments, for example, about the right tradeoff between allowing strong market-based incentives and providing social insurance against economic risks. Such tradeoffs are, of course, at the heart of decisions about tax and transfer policies that affect the distribution of income as well as countless other policy debates.

Policy approaches that would not be helpful, in my view, are those that would inhibit the dynamism and flexibility of our labor and capital markets or erect barriers to international trade and investment. To be sure, the advent of new technologies and increased international trade can lead to painful dislocations as some workers lose their jobs or see the demand for their particular skills decline. But hindering the adoption of new technologies or inhibiting trade flows would do far more harm than good, as technology and trade are critical sources of overall economic growth and of increases in the standard of living.

A better approach for policy is to allow growth-enhancing forces to work but to try to cushion the effects of any resulting dislocations. For example, policies to facilitate retraining and job search by displaced workers, if well designed, could assist the adjustment process. Policies that reduce the costs to workers of changing jobs -- for example, by improving the portability of health and pension benefits between employers -- would also help to maintain economic flexibility and reduce the costs that individuals and families bear as a result of economic change. Of course, devising policies that accomplish these goals in the most effective way is not straightforward, nor can such policies deal with all of the negative effects of trade and technology on affected individuals. Displaced older workers present a particularly difficult problem, as these workers have greater difficulty than others in finding new jobs and experience a greater decline in earnings than other workers if they are re-employed. Considerable debate and analysis of policy alternatives lie ahead, but these discussions will be well worth the effort.

As the larger return to education and skill is likely the single greatest source of the long-term increase in inequality, policies that boost our national investment in education and training can help reduce inequality while expanding economic opportunity. A substantial body of research demonstrates that investments in education and training pay high rates of return both to individuals and to the society at large. That research also suggests that workers with more education are better positioned to adapt to changing demands in the workplace.

In assessing the potential of education and training to moderate inequality, one should keep in mind that the economically relevant concept of education is much broader than the traditional course of schooling from kindergarten through high school and into college. Indeed, substantial economic benefits may result from any form of training that helps individuals acquire economically and socially useful skills, including not only K-12 education, college, and graduate work but also on-the-job training, coursework at community colleges and vocational schools, extension courses, online education, and training in financial literacy. The market incentives for individuals to invest in their own skills are strong, and the expanding array of educational offerings available today allows such investment to be as occupationally focused as desired and to take place at any point in an individual's life.

Although education and the acquisition of skills is a lifelong process, starting early in life is crucial. Recent research -- some sponsored by the Federal Reserve Bank of Minneapolis in collaboration with the University of Minnesota -- has documented the high returns that early childhood programs can pay in terms of subsequent educational attainment and in lower rates of social problems, such as teenage pregnancy and welfare dependency. The most successful early childhood programs appear to be those that cultivate both cognitive and noncognitive skills and that engage families in stimulating learning at home.

To return to the themes I raised at the beginning, the challenge for policy is not to eliminate inequality per se but rather to spread economic opportunity as widely as possible. Policies that focus on education, job training, and skills and that facilitate job search and job mobility seem to me to be a promising means for moving toward that goal. By increasing opportunity and capability, we help individuals and families while strengthening the nation's economy as well.

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