What are the Sources of Wage Inequality?

Oren Levin-Waldman Professor of Public Policy and Public Administration, Metropolitan College of New York

The conventional explanation for growing wage inequality is often referred to as the skills-biased towards technical change theory. This holds that with globalization and increased capital mobility, the economy has changed from industrial production to a post-industrial service based economy. The former did not need a greatly skilled workforce, but the latter, being technologically more advanced, did require much greater skill.

In recent years, however, an alternative explanation has emerged which focuses on deliberate policy choices that were made, which effectively resulted in a deterioration of institutions. This explanation focuses on changes to the tax code that effectively transferred wealth and income from the bottom and the middle to the top, legislative attempts to pass right-to-work laws making unionizing more difficult, packing the National Labor Relations Board with pro-business and anti-labor people, and willful neglect of the minimum wage.

A look at the data, however tells a more complicated story which suggests that as much as the skills-biased technical change explanation is true, its effect on wage inequality was only exacerbated by the deliberate policy choices that effectively resulted in the absence of labor market institutions that have traditionally bolstered the middle class. Put another way, in the face of globalization what is needed, contrary to the conventional wisdom of greater wage and labor flexibility, are stronger institutions that can bolster wages.

Let’s consider the following examples. In 1982, those working in Professional and Technical occupations constituted 19 percent of the labor force and earned median annual wages of $44,666 in 2013 dollars. By 2013 they constituted 27.6 percent of the labor force, an increase of 45.3 percent, and their median wages increased 23.2 percent to $55,000. At the same time, however, those working as craftsmen (more skilled labor) constituted 13.9 percent in 1982 with median wages of $41,039 in 2013 dollars, but declined 30.2 percent to 9.7 of the labor force with median wages of $40,000 in 2013, a decrease of 2.5 percent. Operatives (also more skilled) decreased by 35.3 percent from 15 percent in 1982 to 9.7 percent in 2013, although their median wages increased 10.5 percent from $28,969 to $40,000. Laborers who are perhaps less skilled decreased 12.8 percent from 3.9 percent to 3.4 percent during this period, and their median wages fell 5.9 percent from $26,555 to $25,000.

Meanwhile, on the industry side, the number working in manufacturing decreased 48.3 percent from 23.2 percent to 12 percent in 2013, but their median wages increased 17.3 percent from $38,000 in 2013 dollars to $44,563. Despite the growth in manufacturing wages, it is against the backdrop of a significant decline in the manufacturing base, which by 1982 was still considerably lower than it had been decades earlier. Retail trade, which is where more low-skilled workers tend to be found, increased during this period 10.5 percent from 12.4 percent to 13.7 percent. Although median wages in retail increased 25.7 percent from $21,727 to $27,301, they are still considerably lower than those in Professional and Technical, or those in the more skilled blue-collar occupations.

The one interesting growth industry was Business and Repair Services, which perhaps requires more skill. The number working in this industry increased 93.6 percent from 4.7 percent in 1982 to 9.1 percent in 2013, with median wages increasing 50.6 percent from $26,555 in 2013 dollars to $40,000. And yet, their percentage in the overall distribution was very low in 1982 and continues to be low in 2013.

On the face of it, these examples suggest growth in the number of jobs requiring greater skill and education while there has been a decrease in the number requiring less. This, of course, would support the skills-biased towards technical change model. Economies, however, don’t function in vacuums. They occur within larger political contexts and are very much influenced by public policy. While these transformations were occurring, union membership declined by 46.2 percent from 21 percent in 1982 to 11.3 percent in 2013.

Let us also consider that in 1963, the minimum wage of $1.25 an hour at a 100.6 percent of the U.S. poverty level was in 2013 dollars $9.52 an hour. The willful neglect of the minimum wage, which leaves it at $7.25 an hour means that minimum wage earners are earning 23.8 percent less today than they were in 1963. Even the 1982 minimum wage of $3.35 an hour at 90.6 percent of the poverty line was $8.09 in 2013 dollars. Still, minimum wage workers are earning 10.4 percent less in 2013 than they were in 1982.

Sophisticated statistical testing, which often cannot be easily explained in 30 second sound bites or a short infomercial, also reveals that in 1982, states with high union density were more likely to have lower levels of wage inequality. During the 2000s, there was no statistical significance to union density because it had become irrelevant. Meanwhile states, where the bottom 20th percentile of the wage distribution was higher than the bottom 20th percentile of the national wage distribution were more likely to have lower wage inequality. Moreover, states that passed new minimum wage laws or raised existing ones above the federal minimum wage were more likely to have less wage inequality between 2007 (when many states began to do so) and 2011. Again, institutions matter.

Therefore, it does not completely follow that growing wage inequality is a natural progression because of the forces of globalization. Rather, wage inequality could be reduced were labor market institutions to be strengthened. On the contrary, globalization resulting in a skills-bias towards technical change requires more institutions to ensure unskilled workers continue to have respectable wages that will enable them to purchase goods and services. The answer is not that complicated: wages at the bottom and in the middle need to go up, because if they do not increasing concentrations of wealth will only result in the top .l percent of the top 1 percent pulling further away from the rest of us. Fairness aside, this simply is inefficient because there is a limit to what the very top consumes. After all, it is consumption that drives the economy, and its those in the middle who need to consume.

Posted In: Allied Approaches

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