This is a repository copy of Changes in Human Capital and Wage Inequality in Mexico.
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Popli, G.K. (2007) Changes in Human Capital and Wage Inequality in Mexico. Working
Paper. Department of Economics, University of Sheffield ISSN 1749-8368
Sheffield Economic Research Paper Series 2007001
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Abstract
Over the last two decades Mexico has witnessed a significant increase in wage inequality,
typically attributed to the increase in relative demand for skilled labor. Over this period the
educational achievements and their distribution across the labor force have also changed
substantially. In this paper we analyze the impact of changes in human capital on wage
inequality in Mexico. We focus our analysis on decomposing (1) the level of inequality in
any given year and (2) change in inequality over time, into observable (e.g. age, education,
occupation, etc.) and unobservable differences across workers. The main findings of this
paper are: unobservable factors (within group inequality) account for most of the inequality
in any given year. Among the observable factors human capital emerges as the most
important variables in explaining the level of, and changes in, inequality.
Acknowledgments: I would like to thank David Fairris for his guidance and for
commenting on several preliminary drafts. I would also like to thank Joanne Lindley, Steven
McIntosh, Karl Taylor, the participants of the Eastern Economic Association Conference
(February 2003) and seminar participants at University of East Anglia (April 2003), for their
helpful comments. All errors are mine.
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1. Introduction
Distribution of human capital is one of the most important determinants of the wage
distribution (Card, 1999 and 2001). The impact of human capital can be measured in three
dimensions: changes in average levels, changes in the distribution, and changes in returns.
In Mexico over the last two decades change has been observed in all three dimensions.
Average levels of education have increased, distribution of human capital has become more
equal, and the returns to education have become more unequal. Over this same period
Mexico also witnessed a significant increase in wage inequality.
The literature on rising wage inequality in Mexico has typically attributed it to
increased relative demand for skilled labor leading to increased returns to education (Cragg
and Epelbaum, 1996; Feenstra and Hanson, 1997; Hanson and Harrison, 1999); declining
power of unions (Fairris, 2002); and falling real value of the minimum wage (Cortez, 2001;
Fairris et al, 2006).
An increase in relative demand for skilled labor, leading to increased earnings
inequality is a finding not unique to Mexico.
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What is distinctive about Mexico, however, is
that over this period the educational achievements and their distribution across the labor
force have also changed substantially. That is, the supply of human capital increased as
well. As the supply of skilled labor catches up with the demand, expectation is that
inequality would decrease. In this paper we analyze the impact of changes in human capital
on wage inequality in Mexico, in particular we comment on the impact of the increased
supply of skilled labor on wage inequality – hitherto unexplored for Mexico. Human capital
is acquired in schools and in formal and informal on-the-job training programs, with in-
school acquisition making up an increasingly important component. Here we will focus on
in-school acquisition of skills.
The period covered by this study is 1984 to 2000. We break the two decades into
two distinct periods. The first period, 1984-1994, was marked by structural reforms and
trade and financial liberalization in the economy, rising relative demand for the skilled labor
and rising inequality. The second period, 1994-2000, was one of growth and relative
stability, increasing supply of skilled workers and some evidence of decrease in inequality.
Attempt in this paper is to establish the importance of changing educational endowments and
their distribution in explaining observed changes in wage inequality in Mexico. The analysis
will focus on decomposing (1) the level of inequality in any given year and (2) change in
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inequality over time, into observable (e.g. age, education, occupation, etc.) and unobservable
differences across workers; the observables are further decomposed into their price
(coefficient) and quantity (endowment) effects.
One other paper which directly looks at the impact of educational endowments on
inequality in Mexico is Legovini et al (2005). This paper is distinct from the Legovini et al
paper in two aspects: (1) our paper looks at a longer horizon. Legovini et al look only at the
first period 1984-1994. The supply of skilled labor takes time to catch up to the increased
demand, by extending the analysis to 2000, unlike Legovini et al, we are able to capture the
impact of increased supply of skilled labor on inequality. (2) The methodology used in this
paper is different than that used by Legovini et al. To answer the levels question we use the
methodology proposed by Fields (2003). The benefit of this approach is, the share
attributable to each explanatory factor, in explaining the level of inequality within a year, is
independent of the measure of inequality used.
The main findings of this paper are as follows. First, the unobservable factors
account for most of the inequality in any given year, giving an indication of a rise in within
group inequality. Second, among the observable factors education and occupation emerge as
important factors in explaining the level of inequality. Third, for changes in inequality over
time, the single most important factor is education. In accordance with the literature we find
that changing returns to skill are important in explaining the rise in inequality. Findings in
this paper suggest that once the supply of skilled labor has had a chance to catch up with the
demand, the quantity effect contributes to the decline in wage inequality.
We begin our analysis by describing the data used in this study and outlining the
changes in average educational endowments of the workforce, their distribution, and returns
to these endowments. The subsequent sections will link the changes in education to wage
inequality.
2. Data
The data used for the analysis is from Encuesta National de Ingresos y Gastos de los
Hogares (ENIGH). These are the national household surveys that began in 1984 and
continued in 1989, 1992, and every two years thereafter. This data is nationally
representative, covers a larger share of population, and has detailed information on the skill
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Same reasons have been explored for rising inequality in US and other OECD countries. Refer to Katz and
Autor (1999) and the references therein, for a survey of these findings.
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