Different workers get different pay. This reflects personal characteristics such as education,
job experience, sex, race and union status.
Skills are the most important source of wage differentials. Human capital formation includes
both formal schooling and on-the-job training. Earnings profiles confirm that workers with
more education and training earn higher lifetime incomes.
How much more employers pay for skilled workers depends on the production technology.
The demand for skilled workers depends on the extent to which skilled and unskilled
workers can be substituted and on the output demand for industries that use skilled
workers relatively intensively.
Skilled labour is relatively scarce because it is costly to acquire human capital. Education
beyond minimum age has not only direct costs but the opportunity cost of earnings forgone
by not working immediately. The investment decision for human capital involves comparing
the present costs with the present value of extra income or other benefits in the future.
These considerations are reinforced by the role of education as a screening or signalling
device, which indicates to employers the workers of innate ability. Thus education has a
return to high-ability workers even if it does not directly increase their productivity.
Women and non-whites on average receive lower incomes than white men. Women and
non-whites are concentrated in relatively unskilled jobs with fewer opportunities for
promotion. This need not reflect blatant sexism or racism by employers. It may reflect
educational or other disadvantages before young workers reach the labour market. It may
also reflect a low perceived rate of return by firms on the money spent in training such
workers or by such workers on the time spent in education and skill acquisition.
Under a third of the UK labour force now belongs to a trade union. Unions restrict the labour
supply to firms or industries, thereby raising wages but lowering employment. Unions move
firms up their demand curve for labour.
Unions achieve a higher wage differential for their members the more inelastic the demand
for labour and the more they are willing or able to restrict the supply of labour. However,
some union wage differentials are compensating wage differentials, which unions have
secured in return for changes in work practices that raise productivity but reduce job
satisfaction.
