An Explanation of the Increasing Age Premium

The study examines the reason for the significant increase in the ‘age premium’ over the period 1981-94. The age premium refers to the percentage difference in hourly earnings between ‘younger’ (25-34) and ‘older’ (45-54) workers. In 1994, the hourly rate of older males was 32.4% higher than that of younger males. The corresponding age premium among females was 15.5%. Over the period 1981-94, the age premium increased by 15.7 percentage points among males and 19.5 percentage points among females. Evidence based on analysis of the Survey of Consumer Finances (SCF) public use microdata shows that, while there has been a trend toward non-standard employment, this so far has affected mostly workers under age 25 and cannot explain the rise in the age premium between ages 25-to-34 and 45-to- 54, which is the focus of this study. A more likely explanation identified by the study is the dramatic improvement in the level of education of older workers over the last 14 years. For example, from 1981 to 1994 the percentage of older male workers with grade 10 education or less declined from 41.9% to 19.6%, while the percentage with post-secondary diplomas and degrees increased from 32.1% to 51.7%. The education level of younger male workers also improved over the same period, but the rate of improvement was smaller and, by 1994, there was virtually no difference in the incidence of post-secondary diplomas and degrees between younger and older workers. Similar trends took place among female workers. Shift-share analysis shows that the narrowing of the education gap between older and younger workers explains 44% of the age premium rise among male employees and 50% of the age premium rise among female employees. Thus, this study provides the following likely explanation for a significant part of the increase in the age premium over the period 1981-94: Fourteen years ago younger workers had to compete for jobs with older workers who had more experience but less education. Now, they have to compete with older workers who still have more experience but, on the average, have comparable education to younger workers. As a result, employers are willing to pay a higher premium than in the past for older workers who combine experience with higher education.