A lack of labour protections is fuelling the growing income gap between university-educated Americans and their high school-educated counterparts

Getting a university education can be expensive, and the benefits of having a four-year degree vary a lot depending on where you live. But it has not always been this way.

In the 1980s, university-educated workers in the U.S. and Europe both made approximately the same amount more than workers whose highest level of education was a secondary school diploma. This disparity is called the college premium. In Europe, it has remained relatively stable over the past forty years, but in the U.S., it has more than doubled in the same time frame.

Research by Ruben Gaetani, an assistant professor at the University of Toronto with a cross-appointment to the Rotman School of Management, asks why this divergence has occurred. Working with Matthias Doepke from the London School of Economics and Northwestern University, Gaetani observed that changes in job-tenure distribution align with shifts in the college premium. Put another way, as job tenure in the U.S. declined, income inequality rose. Gaetani and Doepke argue that better employment protections in Europe helped stem the rise of income inequality by incentivizing non-college educated workers and their employers to invest in skills development. The researchers also created a quantitative model that predicts that differences in employment protections will cause this type of divergence during times of economic turbulence — the exact moments when workers need protections most.

“Since the early 1980s, inequality has grown tremendously in many countries, but especially in the U.S.,” says Gaetani. “It increased along most dimensions, including the college premium. In the 1980s, a university-educated person could expect to earn about 50 per cent more than a non-college educated person on average. Forty years later [in the U.S.], this number went up to 100 per cent. University educated workers now make twice as much.”

In comparison, the divergence between college and non-college educated salaries is much smaller in Europe. These economies are highly regulated, and labour laws make it difficult to terminate employees. Greater job security gives workers a stronger incentive to invest the time needed to acquire niche, job-specific skills. These skills also enable non-college educated workers to do their job at a higher level, which increases their value to their employers.

Longer worker tenures also give employers more incentive to invest in training their workers because they know they will be on the payroll for the long term. The combination of time and money invested in workers means they are more skilled and earn higher wages. As a result, the wages of non-college educated workers in Europe have been better able to keep pace, and the college premium has remained relatively stable.

Gaetani’s research is forthcoming in the American Economic Journal: Macroeconomics, and creates a model that uses labour data to explain the phenomenon. It draws data from Germany and Italy, where workers cannot be easily terminated when a company is struggling or there is a wider economic downturn. Labour protections not only provide workers with greater job security, they give both employee and employer an expectation that their working relationship will be long-lived.

“Workers and employers expect that their working relationship won’t just end at the end of the season,” says Gaetani. “It is likely going to last for decades. That creates an expectation which increases the incentives to invest in on-the-job skills.”

Consider a hypothetical scenario of a worker in a German piano manufacturing plant. A single piano has thousands of parts that must be built and assembled with an extraordinary degree of precision to achieve the desired sound. It takes considerable training and expertise to do this, and the skills are so niche that they are not transferable to other roles.

“For a worker to make the decision to go through the training, and for firms to invest so much time to train them depends on whether you expect this relationship to last a sufficiently long time,” says Gaetani. “You can invest in developing the skills needed to produce a piano, but when an economic downturn arrives, if a firm decides to lay off a bunch of workers, those skills are useless elsewhere.”

Conversely, when labour protections are lacking, both worker and firm will anticipate the fleeting nature of their working relationship, reducing their incentive to invest in this type of niche skill. In the U.S., workers can be laid off much more easily, and in recent decades, many have been. At the lower end of the income distribution, employment opportunities have deteriorated dramatically during frequent bouts of economic turbulence. Many manufacturing jobs were relocated to lower-wage economies like China and Mexico, while accelerating technological change rendered other jobs obsolete. Less-educated workers were hit particularly hard.

“When the economy is stable, shocks are infrequent, and labour protection legislation does not make much difference,” says Gaetani. “There is an expectation that workers will remain in a job long enough to justify investing in developing new skills. But economic upheaval disrupts that expectation, and over the past forty years, the world has become a much more turbulent place. International trade has increased and the speed of technological change has been rapid. The economy much less stable, and that means the differences between protected European workers and unprotected U.S. workers started to matter more for the college premium.”

Of course, many new jobs were also created during this period. But many of the jobs created in recent decades have little job security. Improving employment protections for U.S. workers might help narrow the gap, Gaetani argues, but even that has a downside.

“Increasing employment protections for workers who lack them completely might improve their employment opportunities. It could have a positive effect on inequality and other measures of economic well-being,” he says. “But economies that are strongly protected also tend to have much higher unemployment rates because employers know that they will be committed to a long-term relationship if they do hire a worker. So, [employers] are much more skeptical when hiring."