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February 26, 2007

What's Behind Income Inequality

Nothing erases the thrill of getting a raise from your employer faster than the news that some one else got a bigger one.  We care about how much money our friends, neighbors, and co-workers make -- not always in a benevolent sense – even though there is usually very little we can do about it.  The trappings of material wealth are all around us, and it is almost impossible, it seems, not to get caught up in the game.

But despair over disparities in income and wealth are really more than simply envy.  The numbers written on our paychecks inevitably seep into our consciousness as measures of our individual talent and value.  And our faith in the market system can be easily shaken when that system produces outcomes at odds with what we can intrinsically rationalize or comprehend.

The imbalances are in the headlines every day.  Former Home Depot CEO Robert Nardelli received $210 million in severance pay after sending his stock price down 30 percent.  The average pay for CEO’s of S&P 500 companies was 369 times larger than the pay of an average worker last year.  Is a system that bestows these kinds of rewards to those at the top, including the star athletes and entertainers who haul in truckloads of cash, really working?

It’s a fun question to argue, perhaps, but the blowup over the outrageous paychecks of a few executives and celebrities masks something more important that has been occurring in the American economy over the last three decades.  Since the early 1990’s, growth in wages has been more concentrated in the higher end of the earnings spectrum.  Or to put it another way, the rich have been getting richer.

The poor have been getting richer, too.  Since 1973, inflation-corrected wages for those in the bottom half of the earnings distribution have risen by between 5 and 10 percent.  When non-wage compensation – primarily health and retirement benefits – are included, the growth is stronger.  But since that growth rate is much less than the 25-30 percent rise in wages of those with pay in the upper 20 percent of the income distribution, the gap between high and low pay in the economy has increased significantly.

That much of the story is fairly well understood.  Indeed, one of the Democratic Presidential candidates has made the spectre of “two Americas,” rich and poor, part of his stump speech.  But much about how labor markets have produced this result has been missed.

For example, the disparity between the wages of high and low paid workers did not spring into being with the onset of more intensified globalization and technological change in the 1990’s.  In fact, wages at the lower end of the earnings spectrum saw their fastest growth in the last half of the 1990’s, and the spread in wages today is less than it was fifteen years ago, thanks to the remarkable gains in productivity across the entire economy over that period.

In fact, the inequality has been growing slowly and steadily over a span of decades.  And if there is any simple theme that can be said to emerge from this highly complex story it is the value of education.

Despite the increased numbers of college graduates in the workforce, the premium the labor market bestows on those with 4-year and advanced degrees continues to grow every year.  In relative terms, the average high-school educated worker makes about the same inflation-adjusted wage today that he or she made in 1973, whereas the wages of the average worker with an advanced degree have grown by 25 percent.

Let’s hope that those who would solve this problem – if it even is one – learn enough about its cause to keep the cure from being worse than the disease.             

Link to this commentary: https://commentaries.cberdata.org/178/what-s-behind-income-inequality

Tags: income and wages


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He has been involved with economic forecasting and health care policy research for over twenty-four years, both in the private and public sector. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. He attended the University of Michigan, receiving a B.A. ('79) and Ph.D. ('86) in economics.

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