By Nicholas Bloom, excerpt from HBR – March 2017
In 1980, the top 1% of adult earners in the U.S. made $420,000 a year, on average (before taxes and measured in 2014 dollars) — 27 times as much as the average for the bottom 50% of earners. Today the top 1% of earners make an average of $1.3 million a year — 81 times as much as the average for workers in the bottom half. (See the exhibit “Inequality Between Individuals Has Risen.”)
But it’s not just the top 1% who are pulling away. The gap between workers with a college education and ones with only a high school diploma has increased dramatically as well. In 1979, the average annual salary for American men with a college degree was $17,411 higher (after adjusting for inflation) than the average for men with a high school degree. By 2012, the gap had nearly doubled, to almost $35,000; the gap between women with college degrees and those with high school diplomas nearly doubled as well.
Meanwhile, the bottom half of earners in the U.S. have seen virtually no growth in earnings, before taxes and social-security transfers, despite a rise in the number of hours worked. The problem of stagnant incomes for this group is not sluggish GDP growth, as is often suggested; the U.S. economy produces far more each year than it did decades ago. What matters more, a study by Raj Chetty and colleagues demonstrates, is rising income inequality. Their research shows that only half the workers born in 1980 — today’s 36-year-olds — make as much money as their parents did at the same age. When the researchers ran simulations testing the effects of diminishing GDP growth versus rising income inequality on wage stagnation, the percentage of 36-year-olds who did better than their parents jumped to 80% when income inequality was held steady, but only 60% did better when GDP growth was restored to the older, faster rate.
Fewer people realize that firm inequality (the difference in wages across firms) have increased in parallel. Firm inequality, and thus a good part of inequality in general, can be attributed to three factors: the rise of outsourcing, automation and IT, and the cumulative effects of winner-take-most competition.
In considering the effect of outsourcing on inequality, it’s instructive to look at GE. In the 1960s, it employed manufacturing workers, line managers, executives, janitors, administrative staff, and many other types of workers. Over the past several decades, it has automated or outsourced a wide range of functions. Yet during that time its head count has stayed relatively constant, at about 300,000 employees. That means GE has hired more engineers and coders, doubling down on its core competency as the premier maker of high-tech industrial equipment and paying other firms to handle tasks outside its core. Or consider Google. It aggressively recruits software engineers and data scientists, pays them generously, and lavishes them with perks, such as free transportation on buses like the ones protestors threw rocks at. But its bus drivers don’t necessarily see all of those benefits — they’re contractors, not employees.
As companies focused on their core competences and outsourced noncore work, the corporate world began to divide between knowledge-intensive companies such as Apple, Goldman Sachs, and McKinsey and labor-intensive companies such as Sodexo, which provides food service and facilities management services. Workers with lots of education and desirable skills were hired in the knowledge sector, with high pay, perks, and benefits. Less-educated workers got jobs in labor-intensive firms, where pay was stagnant or even falling and benefits such as health insurance were hardly guaranteed. Employees from these two types of firms often work in the same building, but they’re no longer in the same orbit. And when it comes time for the holiday party, the struggling contractors are nowhere to be seen.
Automation and IT
This dynamic appears to be driven largely by technology. My research and other studies suggest that between-firm pay inequality has grown faster in industries that spend more on IT. Investments in technology allow successful online firms to rapidly scale up and reap the benefits of network effects. In this way, leading companies such as Amazon and Facebook dominate their markets. Offline, improved enterprise software and automation of routine tasks make it far easier to manage and grow large businesses, from Shake Shack (burgers) to Xiaomi (smartphones).
Some experts, most notably Jason Furman, the chair of the Council of Economic Advisors during the last three years of the Obama administration, argue that the rise of these “superfirms” results from a lack of competition. Industries have become more concentrated, and the number of new businesses has declined. But industry concentration doesn’t necessarily imply a lack of competition. In some sectors, such as manufacturing, evidence suggests that increased global trade has strengthened the ferocity of competition in recent decades, leading to more domestic competition as fewer and fewer U.S. firms survive. In my view, it’s unclear whether competition has increased or decreased in aggregate over the past few decades.
What is clear is that over the past 35 years, firms have divided between winners and losers, and between those that rely heavily on knowledge workers and those that don’t. Employees inside winning companies enjoy rising incomes and interesting cognitive challenges. Workers outside this charmed circle experience something quite different. For example, contract janitors no longer receive the benefits or pay premium tied to a job at a big company. Their wages have been squeezed as their employers routinely bid to retain outsourcing contracts, a process ensuring that labor costs remain low or go ever lower. Their earnings have also come under pressure as the pool of less-skilled job seekers has expanded, due to automation, trade, and the Great Recession. In the process, work has begun to mirror neighborhoods — sharply segregated along economic and educational lines.
WHAT CAN BE DONE?
The picture of firm inequality I’ve sketched here doesn’t invalidate other theories of income inequality. On the contrary, it supports many of them. And to be clear, although firm inequality is a large part of the puzzle, it’s not everything. Notably, it doesn’t explain the rise of the 1%. That’s a separate and important trend that’s been well documented elsewhere. But in shifting the focus from individuals to companies, several unique recommendations emerge, for both policy makers and executives.
- Focus on antitrust. For a start, a renewed focus on antitrust issues may be a good idea, to the extent that lack of competition can exacerbate the winner-take-most dynamic. But because that dynamic is global, more-robust antitrust policies alone will not solve the problem.
- Reframe the policy debate. Second, established policies should be reassessed through the lens of firm inequality. Take the pay disclosure rules prescribed in the Dodd-Frank Act of 2010, which require companies to disclose the ratio of the CEO’s pay and the median worker’s. Intended to mitigate within-firm wage disparities, the measures may have limited value in light of the research showing that gaps within firms are not the main contributor to income inequality. They may even have unintended consequences: Savvy CEOs may very well decide that the easiest way to raise the salaries of median workers is to outsource more low-wage work, thus lowering the ratio of CEO-to-median pay. As an economist, I’m sympathetic to policies that make more corporate information publicly available, but if the Dodd-Frank disclosure rules are ever closely scrutinized, we may see that they could backfire.
- Reframe corporate decision making and hiring practices. Executives at well-paying firms should recognize the extent to which their strategies and practices contribute to income inequality. You do not need to be a hedge fund manager to be on the winning side of some very profound economic divides. To be sure, companies should not start insourcing all services or stop automating tasks, but senior leaders and those responsible for hiring should understand the role their decisions play in the larger economy.
- Invest in education. Perhaps the single biggest priority for policy makers and corporations should be education. Since between-firm inequality appears to be largely driven by workers being sorted according to education and skills, the best way to set people up for success is to ensure that they have the skills needed to compete in the 21st–century job market. It’s become fashionable lately to point out that more education for ordinary workers wouldn’t alter the extraordinarily high incomes of the top 1%. That’s true: Having more college graduates would do little to rein in the incomes of hedge fund managers and CEOs. But for the equally important inequality between the non-fabulously wealthy and the poorest — between the top 20% and the remaining 80% — education and skills training are clearly part of the solution.
- Boost low incomes through tax policy. Governments should also consider measures that put more money into people’s pockets, such as negative income taxes — meaning that citizens earning below a certain threshold receive money directly from the government. For example, the U.S. should consider expanding the Earned Income Tax Credit, which is basically a negative income tax with a work requirement. Rather than constrain companies with more onerous rules around compensation, negative income taxes supplement the incomes for workers whose skills are in less demand while allowing economies to organize efficiently.
At the very least, it’s time to change the debate around income inequality by recasting the roles of companies from greedy villains or heroic job creators to the fundamental system through which changes in the economy reverberate and the way that most of us get paid. . . .
In her 2012 commencement speech at Harvard Business School, Sheryl Sandberg shared some advice that Eric Schmidt had given her when recruiting her for Google, then a little-known startup. By that point in her career, Sandberg had worked at the World Bank and McKinsey and served as chief of staff to the Secretary of the Treasury. The Google job didn’t seem big enough, and she told Schmidt so. He replied that she needed to pay less attention to the job title and more attention to the trajectory of the organization she’d be joining. His advice was succinct: “If you’re offered a seat on a rocket ship, don’t ask what seat. Just get on.”
It’s good advice, and it illustrates the role that firms play in our economic fates. If you do get the chance to join a rocket ship, take it. But as a society, we need to become more aware of how much of the growing gap between the haves and the have-nots is driven by the advantages that accrue to the lucky few who get seats — and consider doing more to equalize things for those who are left behind on the launch pad, choking on smoke.
NICHOLAS BLOOM Tackling economic principles in common language is a passion for Nicholas Bloom, who describes his work as pub economics or “concepts I can explain to my friends over a pint in London.” Here he takes on common misperceptions about income inequality and proposes a new way of thinking about the problem. Citing Brexit in the UK, the presidential election in the U.S., the Five Star movement in Italy, and the resurgence of Marine Le Pen in France, Bloom says of income inequality, “It’s not only a huge social issue, but it’s now driving global politics.”
Remember the Oxfam report early last year that found sixty-two individuals owned as much wealth as the entire bottom half of humanity put together? It’s gone down to only six — that’s right, six — in the past year: Bill Gates, Warren Buffett, Jeff Bezos, Amancio Ortega, Mark Zuckerberg, and Carlos Slim Helu. The total wealth held by those individuals increased in that time from $343 billion to $412 billion — a 20% increase in one year — bringing their total wealth to an amount equivalent to the total wealth of the bottom 50% of the whole human race.
From sixty-two to six. That’s an astonishing increase in the concentration of wealth: especially in just one year. Sociologist Robert Merton coined the term “Matthew Effect” — “unto every one that hath shall be given” — almost fifty years ago in reference to the phenomenon of the rich getting richer. But never has this concept been so clearly illustrated as it is today. Six people who could carry on an intimate living room conversation are as rich as almost four billion people.
How could this happen? The usual right-wing suspects, professional defenders of what they call “our free enterprise system,” are doing their utmost to reassure us there’s nothing to see here. But the fact that progressively larger shares of wealth are concentrated in fewer and fewer hands should suggest to even the most unobservant that “our free enterprise system” isn’t really very free at all.
As a character in The Illuminatus! Trilogy, by Robert Shea and R.A. Wilson, explained:
“Privilege implies exclusion from privilege, just as advantage implies disadvantage. In the same mathematically reciprocal way, profit implies loss. If you and I exchange equal goods, that is trade: neither of us profits and neither of us loses. But if we exchange unequal goods, one of us profits and the other loses. Mathematically. Certainly. Now, such mathematically unequal exchanges will always occur because some traders will be shrewder than others. But in total freedom— in anarchy— such unequal exchanges will be sporadic and irregular. A phenomenon of unpredictable periodicity, mathematically speaking. Now look about you…and you will not observe such unpredictable functions. You will observe, instead, a mathematically smooth function, a steady profit accruing to one group and an equally steady loss accumulating for all others. Why is this…? Because the system is not free or random, any mathematician would tell you a priori. Well, then, where is the determining function, the factor that controls the other variables…? Privilege… When A meets B in the marketplace, they do not bargain as equals. A bargains from a position of privilege; hence, he always profits and B always loses.”
Equal exchange — that is, exchange between equals — is a positive-sum transaction in which neither party benefits at the other’s expense. Privilege is just the opposite. For every guy who gets a dollar he didn’t work for, Wobbly leader Big Bill Haywood said, there’s another guy who worked for a dollar he didn’t get. The reason is that the exchange isn’t between equals. One party is able to benefit at the other’s expense because they are unequal in power; one of them has the power of the state at their back.
If you look at the richest people and largest corporations in the world, you will find that their wealth comes not primarily from producing things, but from controlling the conditions under which other people are allowed to produce. That’s right — they collect rents for the “productive service” of not obstructing productive activity by other people.
Most of the world’s food is not grown by people feeding themselves on their own land or cultivating their land to produce food for others. It is grown by people working land — most of it stolen — owned by other people who demand tribute for access to it. Most of the world’s manufacturing corporations no longer manufacture anything themselves. They outsource actual production to independent sweatshop employers, and simply use their ownership of “intellectual property” — patents and trademarks — to enforce a monopoly on sale of the finished product. And the biggest concentrations of wealth of all come from the state-granted privilege of lending the circulating medium into existence and advancing credit against future production: a function that, absent bank licensing and legal tender laws, could be performed by the producing classes themselves advancing credit against each other’s future output.
The Gateses and Buffetts of the world, in obtaining their wealth, are every bit as much a beneficiary of the state as any feudal landlord or Soviet commissar.