The battle of institutions vs. technology = rising wage inequality

Summary: Although denied for years, by now rising inequality is acknowledge even by conservatives — so the debate shifts to its causes and remedies. The “standard” answer points to the “invisible hand” of “market forces”. New cutting edge research shows that this defense, much like the earlier denials, does not match the facts. This post excerpts from a important new paper by Tali Kristal and Yinon Cohen in Socio-Economic Review.We cannot fix what we do not understand.

Scales of Income Inequality

The causes of rising wage inequality:
the race between institutions and technology

Tali Kristal and Yinon Cohen, Socio-Economic Review, in press
Excerpt posted with the authors’ generous permission

Abstract

Many inequality scholars view skill-biased technological change — the computerization of workplaces that favours high-skilled workers — as the main cause of rising wage inequality in America, while institutional factors are generally relegated to a secondary role.

The evidence presented in this article, however, does not support this widely held view. Using direct measures for computers and pay-setting institutions at the industry level, this article provides the first rigorous analysis of the independent effect of technological and institutional factors on rising wage inequality.

Analysing data on 43 US industries between 1968 and 2012, we find that declining unions and the fall in the real value of the minimum wage explain about half of rising inequality, while computerization explains about one-quarter. This suggests that much of rising inequality in the USA is driven by worker disempowerment rather than by market forces — a finding that can resolve the puzzle on the diverging inequality trends in USA and Europe.

Excerpt (references omitted)

The sharp rise in wage inequality in the USA and other countries is usually attributed to two sets of factors. The first, advanced by most economists, consists of technological change. The rise of computer technology in the workplace since the late 1970s, so goes the argument, has increased the productivity of, and demands for, high skilled workers that tend to use computers, thereby raising their wages relative to less-skilled workers who do not use computers. Moreover, at the time of rising demand for skilled workers, there was a slowdown in the growth of college graduates, thereby raising the wages of highly educated Americans even more. This explanation, known as skill-biased technological change (SBTC), implies that the invisible hand of the market is the main mechanism through which computerization increases wage inequality.

Most sociologists and political scientists as well as some economists tend to emphasize institutional factors as driving inequality and question the assumption that the invisible hand of the market is the main explanation for rising inequality. They identify mainly pay-setting institutional changes that have occurred in the US labour market and economy since the 1970s — primarily declining unionization and the fall in the real value of the minimum wage, but also the spread of non-standard employment practices as well as the ascent of financialization and globalization — as being responsible for much of the rise in income inequality during that period.

To be sure, the two types of explanation are not mutually exclusive, and most scholars agree that both technology and institutional factors are responsible for rising wage inequality. There is less agreement, however, on the relative importance of each set of factors.

…This article’s contribution, then, is to provide an empirical answer to this debate over the ‘causes of inequality’. Specifically, based on industry-level data, we provide the first empirical test of the main established explanations for rising wage inequality in the USA since the early 1970s. …

2. Why has wage inequality increased?

2.1 Fading pay-setting institutions

In the past four decades, the US labour market has changed dramatically. Some of these changes, in particular the erosion of pay-setting institutions, are partly responsible for the rise in wage inequality. These include the decline of organized labour, the fall in the real value of the minimum wage, the spread of non-standard employment relations, the growth of finance capitalism and the fall of US trade barriers that led to the importation of goods from less-developed countries. Taken together, these changes, which reflect in part a deeper transformation in the political landscape, are responsible for a substantial, yet unknown, portion of the rise in wage inequality since the late 1970s. …

2.2 Computerization, skills and productivity

The ‘canonical’ or ‘consensual’ (Lemieux, 2008) economic explanation of rising inequality asserts a negative relation between the use of new computer technologies in the workplace and wage equality. By new computer technologies, studies generally refer to developments since the late 1960s in semiconductor technology that have found their broadest applications in computing and communications equipment. Such equipment makes extensive use of microelectronics and programmed instructions or software that is implemented at all stages of the production process. As we elaborate below, this well-known SBTC hypothesis holds that computers have increased the productivity of highly skilled workers, which in turn increases their wages. …

5. Discussion and conclusion

In 1997, Alan Krueger, a leading labour economist and contributor to the inequality literature, asked a non-random group of prominent economists what they think are the main causes of rising inequality. In a recent policy speech, Krueger (2012), then the Chairman of the Council of Economic Advisors to the President, reiterated the consensus among his respondents:

“The most important factor … was skill-biased technical change. … A distant second in this poll was other and unknown factors” (‘other’ did not include institutional factors).

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Even Thomas Piketty, whose chapter on labour income inequality (2014, pp. 304–335), sympathizes with institutional explanations, especially the fall in real minimum wage is silent about the effect of union decline on rising wage inequality.

Contrary to that view, we find that the decline of pay-setting institutions is almost twice as important as technology-driven demand for skilled labour in explaining rising inequality within US industries. In fact, the decline of unionization and the real minimum wage explains about 50–60% of rising wage inequality in US private industries between 1969 and 2012, while the spread of computer technology explains 28–29% between 1969 and 1997 and 15–16% between 1988 and 2012, and the slowdown in the supply of educated workers explains 7% between 1988 and 2012.

For reasons we explained earlier, the available US results are different, but similar results showing a larger effect of de-unionization (versus computerization) on inequality were found in Germany, as well as in a study on 22 developed countries.

…One question in the inequality literature is why the US has experienced a sharper increase in wage inequality than European countries, although computer technology, presumably the main cause of rising inequality, diffused about equally across all countries. Our finding that the erosion of pay-setting institutions, in particular labour unions, is the dominant factor which explains rising wage inequality in the USA may help solve this puzzle by pointing to the system of industrial relations as the key factor.

…Evidently, the diffusion of ICT across establishments and industries and the erosion of paysetting institutions are embedded in a larger institutional context that led to an increase in various dimensions of social and economic inequality. In the early post-war accord years, market outcomes were greatly moderated by labour unions, an industrial system of collective bargaining, high minimum wage and progressive taxes. In the past four decades, the social contract between capital, labour and the state has been broken, raising the question whether the sharp increase in earnings inequality has been due to the invisible hand of the market or to what some call the ‘grabbing hand’ of the elite.

Evidence from the current study mainly supports the second possibility, namely that the erosion of pay-setting institutions has enabled business and top earners to grab a disproportionate share of income, leaving most rank and file workers far behind.

———————————– End Excerpt ———————————–

About the authors

Tali Kristal is a Lecturer in Sociology and Anthropology at the University of Haifa. Yinon Cohen is a Professor of Sociology at Columbia. See his website.

Yinon Cohen

Tali Kristal

For More Information

Moshe Y. Vardi (Prof of Computer Science, Rice U) warns that a phase transition in automation approaches — like water into steam. See his analysis at The Conversation.

If you liked this post, like us on Facebook and follow us on Twitter. See all posts about about inequality & social mobility, those describing how the 3rd industrial revolution has begun, and especially see these…

See these books to learn about the new industrial revolution now in progress…

Rise of the Robots
Available at Amazon.
The Future of the Professions
Available at Amazon.
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8 thoughts on “The battle of institutions vs. technology = rising wage inequality

  1. “In the past four decades, the social contract between capital, labour and the state has been broken, raising the question whether the sharp increase in earnings inequality has been due to the invisible hand of the market or to what some call the ‘grabbing hand’ of the elite.”
    …….
    Great stuff. Reads so simply. Seems quite obvious. Power, money, control. Couple this Post with the one from yesterday and the consequences are very hard to enumerate.
    I read here because of such compilations; know of no where else to find these types of assemblages.
    Many thanks.

    Breton

    Liked by 1 person

  2. I work in the technology field and have suspected much of what the authors wrote but could not put my thoughts together in a coherent fashion. Older, more experienced programmers, who started their careers before pay inequality got so serious have managed to retain most of their purchasing power. But it is getting increasingly difficult to persuade managers to even consider hiring younger employees even though, on paper, they have a more useful skill set for the modern workplace.

    As a result, young programmers are now being hired at very low salaries compared to what their older brethren started with 25 years ago. Not surprisingly, the younger programmer leave for greener pastures as soon as they have the requisite experience. This leaves the hiring managers even less willing to hire new blood.

    I have wondered for quite a while what will happen when the older programmers retire. Will the hiring managers finally be forced to hire the younger programmers they have been ignoring? Will they pay equivalent salaries for equivalent work? Or will they outsource the problem or declare that modern technology has reached the stage where

    So far the overall reaction has been to raise the salaries of the remaining older programmers and continue to avoid hiring younger talent. But at the current rate of retirement/burn out, that solution cannot continue much longer.

    Liked by 1 person

    1. Pluto,

      There is a third solution: automation. Deepmind’s AlphaGo program shows the progress being made in machine learning. Writing code seems like a natural development.

      “AlphaGo has the ability to look “globally” across a board—and find solutions that humans either have been trained not to play or would not consider. This has huge potential for using AlphaGo-like technology to find solutions that humans don’t necessarily see in other areas.” {source}

      Like

    2. What you say makes sense in the large picture but I can neither confirm nor deny it in my small part of the world.

      All I can say is that the managers are very frustrated by their decreasing ability to hire people with more than 20 years of experience and are willing to stall highly valued projects to do things with the resources at hand.

      Like

  3. There are alternative explanations to this US centric explanation. The authors allude to some of these in terms of free trade while apparently ignoring the spill-over effects of global labor markets. The Global labor market has a massive over supply of labor at all skill levels in part because the institutional factors that work in China and India – wage setting rules, currency manipulation, internal consumer markets, etc.
    My guess is that the cost of local skilled labor that operates strictly in a local market, e.g., plumbers, electricians, car mechanics, doctors, etc., has in fact kept up and that these folks are doing quite nicely. At the same time, the forces the authors mention certainly play a role as is illustrated in the relative increase in pay of public sector workers whose pay is largely set by institutional factors.
    There is also the complex relationship between the strength of unions and the adoption rate of technology, i.e., think the old telecommunications companies. I have not read the full article so I am not clear how this interaction effect is incorporated in their analysis.

    Liked by 1 person

    1. bernie,

      A problem so complex has to be discussed in “chunks” to achieve any detail. I do not believe these are “alternative” explanations, rather just multiple ones. Understanding the full picture will require putting them together in a larger — and more complex — context.

      This paper compares two explanations: technological change vs. institutional factors.

      Like

    2. Agreed. I should have said “Additional explanations”. On the other hand, I still see their institutional factors as double-edged swords in terms of overall employment, inflation, productivity growth and the overall political process. But the latter is a different line of argument from explaining apparent increasing income inequality.

      Liked by 1 person

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