Are people paid according to their merit?

In human capital theory, which is closely related to the standard labour market model, earnings reflect (marginal) productivity, which is mainly determined by educational attainment. Consequently, higher skilled workers earn more than less skilled workers. This reasoning is, however, largely circular, since individual productivity is difficult to measure and, hence, simply assumed to be equal to the wage. Increasing wage inequality in the past decades is commonly explained by skill-biased technological change (the race between education and technology) and globalisation, but these trends can only explain a small part of the total change in equality. Rising inequality mostly occurred within educational and occupational categories, which is at odds with human capital theory and with changes in supply and demand for different skill levels. Empirical evidence shows that the rise of within-group inequality is primarily caused by institutional changes, in particular the weakening of unions and collective bargaining.