By Daniel Haanwinckel
A recent article by The Brookings Institution argues that income inequality is “a major issue of our time” and cautions that “an increasingly unequal society can weaken trust in public institutions and undermine democratic governance.” That concern is widely shared. According to a recent survey by the PEW Research Center, six in ten U.S. adults say there is too much economic inequality in the country. Social scientists are also concerned: searching for “rising wage inequality” on the JSTOR academic platform yields 877 journal articles published since 1990.
But why does income inequality change over time, and what can societies do about it? Focusing on wages—the primary source of income for most households—Professor Daniel Haanwinckel tackles this question in the paper “Supply, Demand, Institutions, and Firms: A Theory of Labor Market Sorting and the Wage Distribution.” He develops a new theoretical framework to describe how wages evolve depending on trends in educational achievement, changes in demand for skills in the workplace, and minimum wage regulation. Then, he uses the framework to study a curious case where inequality has been falling instead of rising: Brazil between 1998 and 2012.
The novelty of the proposed framework is combining two perspectives about why wage differentials between workers change over time. The first is based on productivity differentials. For example, the computer revolution may have boosted labor productivity, but only for those skilled enough to use them. That should increase their wages relative to less skilled workers. The second perspective is that wage inequality comes in part from the fact that different firms may pay different wages for equally productive workers. Within that perspective, if the labor market becomes more “assortative”—that is, the highly skilled workers become more likely to be employed at high-wage firms—then inequality also rises.
Combining both perspectives into a single model yields novel insights into the effectiveness of education in the fight against inequality. In the PEW survey, most respondents—Republicans and Democrats alike—believe that improving workers’ skills would “do a great deal to reduce economic inequality in the U.S.” This is true in standard economic models that ignore firm wage premiums. But in Professor Haanwinckel’s model, it may not be the case. That’s because the increased supply of skills may change sorting patterns in a way that benefits workers with the highest wages.
A key message of the paper is that, while wage inequality is an important matter, it should not be the only goal for policymakers. Investing in education may be worthwhile even if such investments do not reduce inequality because they may still increase wages for the less educated, reducing poverty rates. And raising the federal minimum wage may sometimes not be desirable, even if it successfully combats wage inequality among employed workers. That’s because falling inequality may come at the cost of reduced employment opportunities for the most vulnerable workers. The best policies to tackle poverty and wage inequality must be chosen case-by-case, using high-quality data and sound economic theory.