Posted by The problem of rising economic inequality in the United States is a complex one. Our last post presented the data. This post will attempt to explain the causes. It is long and somewhat challenging, There are a number of explanations that have been raised for the rising inequality in American income and wealth (see list below).
Possible Reasons for increasing inequality
- The increase in capital’s share at the expense of labor
- Decline in worker’s power because of
- Globalization
- Increased immigration
- Automation
- Declining Real Minimum Wage
- Increasing weakness of unions
- Increase in earnings at the top
- Increase in pay of top executives
- Increase in pay of superstars (athletes, entertainers, investment bankers)
The rise of capital’s share and the decline of labor’s share. Marxist economics holds that the share of income going to capital as an economy grows, will increase at the expense of labor. At the end of the Second World War (1946) labor’s share was 65%; by 2018 that share had decreased to 56.7%. The data on the declining share of GDP being distributed to labor is presented in the figure below. As can be seen over the entire period from 1950 to the present. labor’s share has been declining. In the 53 years between 1947 and 2000, labor’s share declined by 2.1% per year; but in the 14 years between 2000 and 2014, the decline in labor’s share accelerated to 16.3% per year. The
Another way to look at this problem is to look at the dramatic decline in the labor income of the bottom 90% as share of total personal income beginning in 1979 (chart below).
Labor income of the bottom 90 percent as share of total personal income, 1979–2015
Source: Analysis of data from the Congressional Budget Office (2018).
The experience of the United States is unique among advanced countries. Using different definitions of labor’s share of income, Guttièrez and Piton found that for the four biggest European countries, labor’s share (the dashed lines in the figure below) stayed more or less constant or rose for the period after 1990, while in the United States, it fell by 10 percentage points between 1970 and 2013, with most of the decline coming after the year 2000. Since all countries experienced globalization, including increased trade with China, and automation, those are unlikely to be the causes of this phenomenon.
Source: Germán Gutiérrez and Sophie Piton, https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2019/revisiting-the-global-decline-of-the-non-housing-labor-share.pdf
Finally, we should look at the ways in which wages reflect labor productivity (see chart below). Labor productivity and worker compensation track together between 1948 and 1972; but from 1972 on productivity continues increasing at about the same rate; but hourly compensation is largely flat and thus a large gap emerges between the growth of worker productivity and worker compensation.
Labor Productivity growth and hourly compensation growth, 1948–2016
Notes: Data are for compensation (wages and benefits) of production and non-supervisory workers in the private sector and net productivity of the whole economy.
Source: EPI analysis of data from the Bureau of Labor Statistics; https://www.epi.org/publication/what-labor-market-changes-have-generated-inequality-and-wage-suppression-employer-power-is-significant-but-largely-constant-whereas-workers-power-has-been-eroded-by-policy-actions/
There are four separate data series that all in one way or another track with the decline in the share of income going to the middle classes:
- The decline in labor’s share of GDP, which accelerated between 2000 and 2016.
- The decline in the labor income of the bottom 90% as a share of personal income which begins in 1979.
- The trend for wages to no longer track with labor productivity which begins in 1970.
- The increase in economic inequality which we saw in the previous post largely began around mid-1970s.
Bivens and Shierholz argue that the key to the increase in inequality has been the weakening of the bargaining power of labor. This is a result of the weakening of unions, the decline in the real minimum wage, the increase in competition for low-wage goods from abroad and increased low skilled immigration. The chart below shows the decline in union membership between the 1930’s and 2010. At the end of WWII union membership peaked at 35.5%; but by 2010 that share had fallen to 6.9% of all private sector workers and 11.8% of all workers (unionization had increased in the public sector).
Unions and Labor Legislation. The policy environment for labor unions was established in 1935 with the passage of the National Labor Relations Act (NLRA) of 1935 (also known as the Wagner Act). The NLRA guaranteed the right of private sector employees to organize into trade unions, engage in collective bargaining, and take collective action such as strikes. The Law established the National Labor Relations Board to prosecute violations of labor law and to oversee the process by which employees decide whether to be represented by a labor organization. It also established various rules concerning collective bargaining and defined a series of banned unfair labor practices, including interference with the formation or organization of labor unions by employers. The act was bitterly opposed by the Republican Party and business groups. The American Liberty League viewed the act as a threat to freedom and engaged in a campaign of opposition in order to repeal these “socialist” efforts. This included encouraging employers to refuse to comply with the NLRB and supporting the nationwide filing of injunctions to keep the NLRB from functioning. This campaign continued until the NLRA was found constitutional by the Supreme Court in National Labor Relations Board v. Jones & Laughlin Steel Corporation (1937).
As can be seen in the chart above, the rise in union membership dramatically increased with the passage of the NLRA. However, in 1947, Congress passed a new labor law, the Taft-Hartley Act, which prohibited jurisdictional strikes, wildcat strikes, solidarity or political strikes, secondary boycotts, secondary and mass picketing, closed shops, and monetary donations by unions to federal political campaigns. The NLRA also allowed states to pass right-to-work laws banning union shops. Enacted during the early stages of the Cold War, the law required union officers to sign non-communist affidavits with the government. While there are many reasons for the decline in union membership (including the shift in production from manufacturing to the service sectors), it is clearly from the timeline above that union membership declined from the passage of Taft-Hartley to today.
The chart below compares unionization in the United States with other countries. Among advanced countries, only France has a lower rate of unionization than the United States.
Another factor eroding labor’s power has been the decline in the real minimum wage. As can be seen from the chart below, the real minimum wage (blue line) is now at the same level it was in 1950 and well below its peak in the early 1970s.
What is happening at the top of the income distribution? Finally, we should turn to the high end of the labor market, which includes superstars with unique talents (entertainers and athletes), high level professionals (doctors, lawyers and investment bankers), and CEOs. The chart below tracks the income of the top 0.1% of earners in the United States compared to France and Japan. As can be seen, at least with respect to Japan and France, the share of income going to the top 0.1% in the U.S. is exceptional. For that reason, explanations such as technological change (which many authors, such as Korink and Ng, have suggested are the cause of the increase in the incomes of “superstars”) and globalization have to be questioned. The unique experience of the United States suggests another explanation.
Percentage of National Income (excluding capital gains) received by top 0.1% of income earners in the United States, France and Japan (1981 to 2006)
In 2017 CEOs made 311 times the income of a typical worker, while in 1970 that ratio was only 20 (see chart below). One explanation for this phenomenon is the divergence of corporation management from shareholders, which has enabled management to offer itself dramatic compensation increases, many in the form of stock options. As can be seen from the following table from Bajika, Cole and Heim the vast majority of income of the top 0.1% comes from business executives, medical personal, and lawyers, not from athletes, entertainers or scientists.
In their new book Pay Without Performance: The Unfulfilled Promise of Executive Compensation, Lucian Bebchuk and Jesse Fried make the case that the executive compensation system in the U.S. is fundamentally broken. They write: “Compensation arrangements have often deviated from arm’s-length contracting because directors have been influenced by management, sympathetic to executives, insufficiently motivated to bargain over compensation, or simply ineffectual in overseeing compensation…Executives’ influence over directors has enabled them to obtain “rents”—benefits greater than those obtainable under true arm’s-length bargaining.”
But there’s another important reason for the rapid increases in CEO compensation. They have been producing for their shareholders. Since 1980, the Standard and Poor’s Index has increased by 8.7% per year, enriching stockholders and allowing them, in turn, to enrich CEO’s, who receive much of their compensation in stock options.
Conclusions. The U.S, is exceptional in its income inequality. There are a number of explanations for the increase of income inequality in the United States. At the core has been two major policies: 1) government hostility to labor unions as expressed in the Taft-Hartley Act, and 2) macroeconomic policy which has led to the very fast rise in the value of shareholder equity and thus permitted CEO compensation to skyrocket.
For middle income earners the main reason has been the loss of bargaining power associated with the decline in unions. This decline can be associated with the decline in manufacturing and other heavy industry, but also with legislation, particularly the Taft-Hartley Act passed in 1947.
For the very top the dramatic increase of the top 0.1% of all earners is best explained by the rapid increase of business executive pay, which, in turn, is likely the result of rapidly growing stock values and the decreasing accountability of corporation management to stockholders.
Very interesting data Jerry — thanks for posting. Looking at it from the very top level, I would think that our economy has two primary objectives: 1) to support a system whereby people who work consistently and with reasonable effort are able to support themselves and their family, and 2) that the system reasonably differentiates financial rewards based on education, skill, talent, and effort.
Using those goals as a starting point, my primary comment from viewing the data posted is on the huge disparity between CEO compensation (along with other high-level executives) and that of the typical worker (or median salary) for that organization. That disparity appears to be patently unfair, and is something that could be addressed by legislation. Although the CEO and other top-level folks in any organization clearly have more responsibilities and pressures, and therefore deserve more compensation, they are also clearly way more advantaged in terms of negotiating positions for salaries since they, and their families, have the financial means to do so. The lower end employees are often living paycheck to paycheck, and have much less ability to negotiate. Therefore, some reasonable limits on the pay differentials seem warranted.
Moreover, I’ve always been a fan of the “employee owned” companies, where employees have the opportunity to be partly compensated with company stock, and therefore benefit when the company benefits. That would also apply to the CEO and top executives of the company. If they were compensated more by company stock than by straight salary, then they would be more accountable for company performance. If the CEO and top executives do a good job with leadership and management, then everybody wins. As for Unions, I believe they are only applicable in the case of very large companies (e.g., GM, etc.), where the company performance is more stable than in smaller companies. Without having done any research in this area, my experience tells me that competent trades people (plumbers, electrians, etc.) who work hard tend to do very well financially.