Income inequality, labor market inequality

The report published recently by the Paris School of Economics measures income and wealth inequality around the world and reveals the high share of total income accounted for by the top earners, reflecting a very worrying situation. The report notes that the top 1% of earners worldwide captured 27% of total income growth since 1980 (net of inflation), while the bottom 50% captured only 12% of income growth over the same period. The world’s reference points have definitely changed over this period. Individual country income-inequality trajectories are sometimes even more stark, but inequality in Europe has remained relatively stable since 1980.

Income distribution inequality raises a number of questions, particularly the challenge of achieving strong and sustainable growth. If growth only benefits a very small minority, then our aims cannot merely be restricted to growth at any price. The trickle-down theory whereby the poor derive benefits when the rich get richer is clearly not working, so it is vital to come up with different targets and mechanisms alongside growth to ensure a more balanced society.

Some observers attribute Trump’s election success in the US last year to part of the population feeling that growth had passed them by, as illustrated by Branko Milanovic’s famous elephant chart, which suggests that US low and middle classes became worse off over the 1998-2008 period. They watched growth, had the drive to want to get a job, but it was all of little comfort to them.

So achieving growth at any price, even the exceptional growth promised by Donald Trump and his tax reform, is not the right answer if it only benefits the small minority that captures income growth, while leaving most of the US population by the wayside.

The issue of income distribution had previously been addressed in the 1950s and 1960s using progressive taxation, and it has reared its ugly head again since the 1980s, generating very real sources of frustration and the ensuing risk of political and social instability.

This phenomenon does not affect Europe as severely as the US and some emerging countries, such as India. However, inequality can also emerge via the labor market and corporate behavior. Recent research suggests that we can no longer use a standard corporate model for our analysis. It was very useful to take a representative fictional company and apply reasoning to a standard behavior model, which was not too far removed from the reality of the situation. However, over the past ten years, analysis has changed and we are now witnessing companies within the same business sector display extremely different behavior, primarily on innovation.

An analysis of a sample of 16 OECD countries, including the largest members, reveals significant divergence in productivity profiles from one company to another. The most efficient 10% of companies boast a significant productivity gap over the least productive 10%, and it widens each year. Other productivity inequality metrics reveal identical results or showings that are consistent with these findings. Meanwhile, wages paid out follow the same trend: the divergence in wages paid out is similar to differences in productivity.

Companies have very different profiles depending on their degree of efficiency and this leads to significant and long-lasting wage gaps that seem impossible to bridge.

This situation is probably part of the reason why inflation is so absent from our current economic cycle. Efficient companies can pay out high wages, which are the result of strong productivity, without having to raise their prices. Meanwhile, inefficient companies do not pay out higher wages as they cannot pass the cost onto prices due to fiercer competition. So average wages have little scope for progress. We may observe a range of very high wages within a certain sector or type of company, but this is not representative across the board.

We may well wonder whether these diverging productivity trajectories lie at the very root of the failure to stage a recovery in productivity in the current economic cycle. There are some very productive companies, but the average remains very restricted due to the vast disparity among businesses.

So we can raise the question as to whether convergence towards an overall positive impact from innovation is ultimately possible. This would require innovation from the most efficient sectors to spread to the others, which is possible but would take time if it were to happen. The process could take another ten years or even more, and if this best-case scenario were to materialize, it would prompt strong productivity gains worldwide and promote convergence of the wage trajectory.

Two comments are worth making:

If convergence does not happen, then divergence between companies will continue and worsen, and the impact on a worldwide scale will be tantamount to secular stagnation.

Nick Bloom posits that the most efficient companies in the US are new technology and platform economy companies. If he is right, these are companies with increasing returns for which each additional client is profitable as he/she carries no extra cost. The rest of the economy obeys the law of diminishing returns, as it has done for centuries, whereby each new client costs a little bit more each time and is therefore that bit less profitable. Is it feasible for all companies to achieve increasing returns? It most certainly is not.

So a fundamental question arises: the divergences observed suggest that employees need to choose the right company from the outset, regardless of the qualifications they attain. This adds a fresh challenge for workers to address.

The world is changing but this change goes hand-in-hand with further income inequality. We are facing a major macroeconomic challenge that requires a rethink of the whole way we live together as a society. But that goes way beyond mere economics.

The French version of this paper has been published first on my LinkedIn page. As one of the 25 Top Voices for LinkedIn in France in 2017. (I was already in this list for 2016). See the list here (in French)

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