Causes of income inequality in the United States

Causes of income inequality in the United States describes the reasons for the unequal distribution of income in the US and the factors that cause it to change over time. This topic is subject to extensive ongoing research, media attention, and political interest.

Income inequality in the United States grew significantly beginning in the early 1970s, after several decades of stability.Piketty, Thomas (2014). Capital in the Twenty-First Century. Belknap Press. "The Explosion of US Inequality after 1980": pp. 294–96. The US consistently exhibits higher rates of income inequality than most developed nations, arguably due to the nation's relatively less regulated markets.Weeks, J. (2007). Inequality Trends in Some Developed OECD countries. In J. K. S. & J. Baudot (Ed.), Flat World, Big Gaps (159–74). New York: ZED Books (published in association with the United Nations).Income distribution and poverty – OECD. OECD

According to the Congressional Budget Office, "the precise reasons for the [recent] rapid growth in income at the top are not well understood", but "in all likelihood," an "interaction of multiple factors" was involved.Congressional Budget Office: "Trends in the Distribution of Household Income Between 1979 and 2007". October 2011. p. 13 Researchers have offered several potential rationales.Congressional Budget Office: "Trends in the Distribution of Household Income Between 1979 and 2007". October 2011. p. xi Various rationales conflict or overlap. They include: Globalization – Lesser-skilled American workers have been losing ground in the face of competition from workers in Asia and other emerging economies. Changes in labor demand – The rapid pace of progress in information technology has increased the relative demand for higher-skilled workers. Superstar hypothesis – Compensation in many sectors turned into a tournament in which the winner is richly rewarded, while the runners-up get far less. This affects both workers and investors (in dominant firms).the superstar hypothesis was coined by the Chicago economist Sherwin Rosen) used the example of the passing of the hundreds of comedians that made a modest living at live shows in the borscht belt and other places in bygone days that have been replaced by a handful of superstar TV comedians. Tax policy – Pre-tax income inequality in the U.S. is similar to other developed countries, but markedly rises after taxes and transfers. Immigration – Relatively high levels of immigration of less-skilled workers since 1965 may have reduced wages for American-born high school dropouts., estimate by economist George Borjas Decline of unions – Unions helped increase wages, benefits and working conditions. Unionized workers declined from over 30% to around 12%. Social norms – Social norms constrained executive pay. CEO pay rose from around 40 times the average workers pay in the 1970s to over 350 times in the early 2000s.

Divergence of productivity and compensation

Overall One view of economic equity is that employee compensation should rise with productivity (defined as real output per hour of labor worked). In other words, if the employee produces more, they should be paid accordingly. If pay lags behind productivity, income inequality grows, as labor's share of the output is falling, while capital's share (generally higher-income owners) is rising. According to a June 2017 report from the non-partisan Bureau of Labor Statistics (BLS), productivity rose in tandem with employee compensation (a measure which includes wages as well as benefits such as health insurance) from the 1940s through the 1970s. However, since then productivity has grown faster than compensation. BLS refers to this as the "productivity-compensation gap", an issue which has garnered much attention from academics and policymakers. BLS reported this gap occurs across most industries: "When examined at a detailed industry level, the average annual percent change in productivity outpaced compensation in 83 percent of 183 industries studied" measured from 1987 to 2015. For example, in the information industry, productivity increased at an annual average rate of 5.0% over the 1987-2015 period, while compensation increased at about a 1.5% rate, resulting in a 3.5% productivity gap. In Manufacturing, the gap was 2.7%; in Retail Trade 2.6%; and in Transportation and Warehousing 1.3%. This analysis adjusted for inflation using the Consumer Price Index or CPI, a measure of inflation based on what is consumed, rather than what is produced.

Analyzing the gap BLS explained the gap between productivity and compensation can be divided into two components, the effect of which varies by industry: 1) Recalculating the gap using an industry-specific inflation adjustment ("industry deflator") rather than consumption (CPI); and 2) The change in labor's share of income, defined as how much of a business' revenue goes to workers as opposed to intermediate purchases (i.e., cost of goods) and capital (owners) in that industry. The difference in deflators was the stronger effect among high productivity growth industries, while the change in labor's share of income was the stronger effect among most other industries. For example, the 3.5% productivity gap in the information industry was composed of a 2.1% difference in deflators and about a 1.4% due to change in labor share. The 2.7% gap in Manufacturing included 1.0% due to deflator and 1.7% due to change in labor share.

Reasons for the gap BLS explained the decline in labor share as likely driven by three factors that vary by industry: Globalization: Income that might have gone to domestic workers is going to foreign workers due to offshoring (i.e., production and service activities in other countries). Increased automation: More automation means more share of income attributed to capital. Faster capital depreciation: Information assets depreciate more rapidly than machinery; the latter were the greater share of the capital base in the past. This may require a higher capital share to generate income than in the past.

Market factors

Globalization

Globalization refers to the integration of economies in terms of trade, information, and jobs. Innovations in supply chain management enabled goods to be sourced in Asia and shipped to the United States less expensively than in the past. This integration of economies, particularly with the U.S. and Asia, had dramatic impacts on income inequality globally.

Economist Branko Milanovic analyzed global income inequality, comparing 1988 and 2008. His analysis indicated that the global top 1% and the middle classes of the emerging economies (e.g., China, India, Indonesia, Brazil and Egypt) were the main winners of globalization during that time. The real (inflation adjusted) income of the global top 1% increased approximately 60%, while the middle classes of the emerging economies (those around the 50th percentile of the global income distribution in 1988) rose 70–80%. For example, in 2000, 5 million Chinese households earned between $11,500 and $43,000 in 2016 dollars. By 2015, 225 million did. On the other hand, those in the middle class of the developed world (those in the 75th to 90th percentile in 1988, such as the American middle class) experienced little real income gains. The richest 1% contains 60 million persons globally, including 30 million Americans (i.e., the top 12% of Americans by income were in the global top 1% in 2008), the most out of any country.

While economists who have studied globalization agree imports have had an effect, the timing of import growth does not match the growth of income inequality. By 1995 imports of manufactured goods from low-wage countries totalled less than 3% of US gross domestic product."The United States of Inequality, Entry 7: Trade Didn't Create Inequality, and Then It Did," by Timothy Noah (September 14, 2010)

It wasn't until 2006 that the US imported more manufactured goods from low-wage (developing) countries than from high-wage (advanced) economies."Trade and Wages, Reconsidered", by Paul Krugman (February 2008) Inequality increased during the 2000–2010 decade not because of stagnating wages for less-skilled workers, but because of accelerating incomes of the top 0.1%. Author Timothy Noah estimates that "trade", increases in imports are responsible for just 10% of the "Great Divergence" in income distribution.

Journalist James Surowiecki notes that in the last 50 years, companies and the sectors of the economy providing the most employment in the US – major retailers, restaurant chains, and supermarkets – are ones with lower profit margins and less pricing power than in the 1960s; while sectors with high profit margins and average salaries – like high technology – have relatively few employees.

Some economists claim that it is WTO-led globalization and competition from developing countries, especially China, that has resulted in the recent decline in labor's share of income and increased unemployment in the U.S.Smith, Noah (January 6, 2014.). The Dark Side of Globalization: Why Seattle's 1999 Protesters Were Right. The Atlantic. Retrieved January 10, 2014. And the Economic Policy Institute and the Center for Economic and Policy Research argue that some trade agreements such as the Trans-Pacific Partnership could result in further job losses and declining wages.No Jobs from Trade Pacts: The Trans-Pacific Partnership Could Be Much Worse than the Over-Hyped Korea Deal. Economic Policy Institute. July 18, 2013Gains from Trade? The Net Effect of the Trans-Pacific Partnership Agreement on U.S. Wages . Center for Economic and Policy Research. September 2013

One argument contrary to the globalization/technology hypothesis relates to variation across countries. Japan, Sweden and France did not experience significant increases in income inequality during the 1979–2010 period, although the U.S. did. The top 1% income group continued to receive less than 10% of the income share in these countries, while the U.S. share rose from 10% to over 20%. Economist Emmanuel Saez wrote in 2014: "Differences across countries rule out technical change/globalization as the sole explanation ... Policies play a key role in shaping inequality (tax and transfer policies, regulations, education)."

Superstar hypothesis Eric Posner and Glen Weyl point out that inequality can be predominantly explained by the superstar hypothesis. In their opinion Piketty fails to observe the accelerated turnover that is occurring in the Forbes 400; only 35 people from the original 1982 list remain today. Many have fallen off as a result of heavy spending, large-scale philanthropy, and bad investments. The current Forbes 400 is now primarily made up of newly wealthy business owners, not heirs and heiresses. Thomas Piketty Is Wrong: America Will Never Look Like a Jane Austen Novel, Eric Posner and Glen Weyl, New Republic, 2014 In parallel research, the University of Chicago's Steven Kaplan and Stanford University's Joshua Rauh note that 69% of those on the Forbes list are actually first generation wealth creators. That figure has risen dramatically since 1982 when it stood at 40%. It's the Market: The Broad-Based Rise in the Return to Top Talent Steven N. Kaplan and Joshua Rauh , 2014