The Effect of Human Capital on Income Inequality: An Econometric Analysis

Anette Løndal Johansen

Student thesis: Master thesis


The question of how inequality is generated and evolves over time has been a main concern of social scientists for more than a century. The world is experiencing a global income inequality at a high level, whereby the richest eight per cent of the world’s population earn half of the world’s total income, while the remaining 92 per cent are left with the other half. The dimension of global inequality is likely to become even more relevant as the world becomes more integrated. At the same time income inequality is seen as an important component for a country’s overall development, which makes it important to understand the sources that are affecting it. The purpose of this thesis is to investigate and analyse the effect of human capital on income inequality. Human capital is important because it is the knowledge and competencies that can be used to produce economic value, but also for its relation to economic growth and the distribution of income. This thesis uses educational attainment as a proxy for human capital to investigate its effect. Income inequality is presented as the Gini coefficient, which measures the degree of inequality in the distribution of income in a country. This thesis outlines the importance of education because it influences the skills and competencies of individuals as well as peoples productivity. Therefore, improved education can be important for the wage people will receive, thus impact the income they will hold. The relation between education and income inequality has been the motivation for the empirical investigation in this thesis. The results presented are taking advantage of new and broader compiled datasets that help explain the effect of human capital on income inequality. The final dataset used for the empirical investigation contains data on 123 countries from 1960 to 2010. This dataset are making it possible to use econometric methods that among others are able to address the problem of reverse causality i.e. are people more educated because they have a higher income or do people have a high income because they have a higher education? A two-least square estimation is used to address this problem of endogeneity with the use of parents’ education as an instrument. The result of the instrumental variable estimation is presenting a positive and significant relation between improved educational attainment and income inequality. The empirical results presented in this thesis are all supporting this positive relation, that is, improved educational attainment is reducing income inequality.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2014
Number of pages73