Rising Skill Premium, Education Funding, and Education Decision

ABSTRACT This paper analyzes the effects of an increase in earnings inequality between skilled and unskilled workers (rising skill premium) on education decisions, intraskilled inequality, and intergenerational mobility, depending on the way higher education is funded. The rise in the skill premium encourages higher education enrollment. When higher education is costly for individuals or their families, a rising skill premium (i) improves the relative position of children from skilled families, (ii) reduces interskill intergenerational mobility, and (iii) fosters inequality across skilled workers (“intraskilled inequality”). The impact depends on education funding, and the only situation in which skilled families are not favored is when higher education is freely provided. In this case, the increase in university enrollment must come with an increase in public expenditure on higher education to prevent the deletion of the highest skills. These results are in line with the developments observed in the last four decades in advanced economies, where the constant increase in the skill premium has come with a general increase in the educational level of the population, which has been higher at the top of the skill ladder.