Investigating Income Inequality

Till Von Wachter

Till Von Wachter

It is well known that income inequality in the United States has risen substantially since the early 1980s. However, the sources of the ongoing rise in inequality are still debated. Yet, an understanding of these sources is important for assessing potential policy options to address potential adverse consequences of inequality. In his recent paper “Firming Up Inequality,” Professor Till von Wachter substantially improves our understanding of these issues by examining the role firms have played in the observed rise in inequality.

The major economic hypotheses put forward to explain rising inequality are intimately related to workers’ employers. Yet, very few studies had access to the necessary information to analyze the evolution of income inequality within and between firms.  A classic hypothesis is that adoption of more computer-intensive technologies has increased the demand of more skilled workers and reduced the demand for routine, manual labor. If some firms adopt new technologies earlier than others and share some of the resulting profits with their workers, this could lead to a rise in differences in mean pay between firms. Alternatively, if early adopters raise wages of higher skilled workers this could imply within-firm wage inequality to rise faster in some firms than others. Changes in technology can also affect the organization of production and which workers firms hire. While this has received less attention in the literature, such reorganization can have profound consequences for inequality. For example, if high-wage firms increasingly hire high-skilled workers, such changes in worker composition can also lead to a rise in differences in mean pay between firms and an increase in income inequality as a whole.

In his paper, Professor von Wachter studies the role of firms for rising inequality using a massive, new longitudinal data set from the Social Security Administration that contains information on earnings for all workers ever employed in the United States since 1980 to the present time. Professor von Wachter obtains three key findings. The first finding is that firms appeared to have played a key role in rising inequality –over two thirds of the rise in inequality in the United States from 1980 to today occurred due to a rise in inequality in average pay between firms. Strikingly, Professor von Wachter documents that this rise in differences in mean pay between firms was entirely driven by changes in which workers firms hired. In contrast, differences in wage premiums between firms, holding constant worker composition, have remained roughly stable in the United States since the early 1980s. Finally, the paper also documents that for workers at large firms and for top employees in general, a more substantial rise in inequality has actually occurred within firms.

The fact that changes in worker composition between firms plays such an important role in explaining rising inequality has important implications. The findings suggest the rise in inequality in the United States has been related to a substantial reorganization in production that has led to a concentration of high-skilled (and hence high-wage) workers at firms that pay above average wages. Professor von Wachter also presents evidence that high- and low-skilled workers are increasingly like to be working in different firms, even independently of firm pay. These findings are consistent with other evidence documenting a rise in both domestic and foreign outsourcing of U.S. companies, as well as a rising concentration of low-wage and high-wage occupations between firms in the U.S. and other countries. It appears firms have increasingly reorganized their production around more homogeneous work forces.

This ongoing reorganization has shaped the way Americans work, with important consequences for inequality and for the economic opportunities of lower-skilled individuals. Obtaining a job at a high-wage firm has increasingly become a privilege for high-skilled workers. In contrast, in the 1960s and 1970s low-skilled workers had access to high-wage employers and work environments with high-skilled workers. In other words, it does not appear that the availability of high-wage jobs has been changing, but that these good jobs have been increasingly been taken by high-skilled workers. At the same time, lower-skilled workers are now less likely to work with high-skilled workers, potentially limiting their productivity. What the underlying economic forces behind the ongoing reorganization of production are is an important question for future research.