Tuesday, March 24, 2015

Widening inequality and declining returns to labor

The conventional wisdom on increasing inequality across the world lays the blame on rising returns to capital complemented by declining (or stagnant) returns to labor.

These two trends revolve around three causal factors - trade, technology, and politics. Globalization and trade liberalization has increased the global supply of labor relative to capital; technological changes have lowered the price of capital and increased the substitutability of capital and labor, especially less skilled labor, thereby lowering the demand for labor; and political ideological shifts have undermined labor bargaining capacity. Four recent papers lend credence to the aforementioned factors.

1. Holger Mueller, Elena Simintzi, and Paige Ouimet, using firm-level data, find that "wage differential between high and either medium or low-skill jobs increase with firm size". This coupled with the increasing share of employment by the largest firms appears to point to rising firm-size as contributing to widening inequality. The benefits of size are appropriated by the skilled and senior workers at a firm - a cleaner or salesman in a small retail shop or big chain retailer gets similar salaries whereas the wage differential for managers is substantial. And the big chain retailers have been squeezing out the small shops.

2. Albert Bollard, Peter Klenow, and Huiyu Li examined manufacturing sector in US, China and India over 1982-2007 and find a rising trend towards larger sized firms. They reason that bigger firms have higher productivity, which in turn raises the barriers to entry for new and smaller competitors and entrenches the incumbents. The increased entry cost stems from "rising cost of labor used in entry, as well as higher output costs of setting up a business to use more sophisticated technologies".

3. Lukas Karabarbounis and Brent Neiman document a secular (across countries and industries) decline in global labor share of income over the past 35 years. They credit it to decrease in the relative price of investment goods, often attributed to advances in information technology and the computer age, which in turn induced firms to shift away from labor and toward capital.

4. Francisco Rodriguez and Arjun Jayadev document a similar secular decline in the labor share of income in manufacturing sector over the past three decade. They also find that "this decrease is driven by declines in intra-sector labor shares as opposed to movements in activity towards sectors with lower labor shares", thereby appearing to corroborate the findings of Karababounis and Neiman. 

No comments: