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What’s Really Driving Income Inequality?

by DAVID ROSNICK

Over the last several decades, inequalities in both incomes and wealth have grown substantially within the United States and in other high-income nations. In the United States, for example, the income share of just the top one half of the top 1 percent grew from 5.39 percent of the nation’s income in 1979 to 13.37 percent in 2010. By contrast, over this same period the share of the bottom 90 fell from 67.65 percent to 53.74 percent.

With the aim of examining the causes of this shift in earning, the Organisation for Economic Co-operation and Development, known as the OECD, recently published a lengthy book on the subject, titled Divided We Stand: Why Inequality Keeps Rising. Despite a wealth of data presented in the tome, the authors of the study largely failed to explain why, in fact, inequality keeps rising.

First, they focus largely on the relatively high wages of the 90th percentile of earners to that of the 10th percentile, which misses the fact that much of the increase in inequality was well above the 90th percentile. Again, with the United States as an example, growth in wages at the 90th percentile of wages only just kept pace with the overall average. Ninety percent of the distribution failed to keep up.

Though the OECD study does devote some time to discussion of inequality at the very top—including compensation in the financial sector—they do not draw any connection between what happened at the very top to what they observed in the broader economy. To some extent, increasing inequality between the 90th and 10th percentiles reflects the former shielding itself more effectively from the redistribution to the 99th percentile.

On the other hand, they do find that increased post-secondary education was a significant equalizing factor. This is the flip side of the top-income effect, as a more educated workforce created increased competition for higher (but not necessarily very high) paying work.

So if not the incomes of the very top, to what does the OECD attribute the increase in inequality? In large part, the authors find that the deterioration of certain institutions and policies are to blame. They report that falling union coverage, weakened product market and employment protection regulation, and shrinking tax wedges have all contributed to increased inequality.

The authors then attribute much of the increase in inequality to technology. Unfortunately, their chosen measure is the cyclical component of business spending on research and development. Though their analysis points to their measure as a statistically significant factor, it is difficult to explain a decades-long trend with a variable that by construction should be unchanged over the business cycle. In fact, working from the OECDs’ data, we found that the trend in research and development spending over this period explained none of the rise in inequality.

If increased post-secondary education is not offsetting technology, as the authors suggest, but only weakened institutions, then we still require an explanation for the increase in inequality in recent decades. Our reproduction of the OECD analysis shows that the combination of all explained effects in the model is likely equalizing on balance, leaving the trend of increased inequality entirely unexplained. In other words, while the OECD finds there are some factors that contribute to inequality and other factors that equalize wages, they failed to explain the shift in incomes toward the top.

Our analysis suggests alternatively that increased financial sector compensation has been an important driver of inequality. Quite apart from this finding, it is unfortunate that the authors of the OECD study appear to have missed their own story. Perhaps in the future we will see less blame on “technology” and greater attention paid to other factors that may contribute to inequality—such as the large rents that are earned by bankers operated in a bloated financial system.

David Rosnick is an economist at the Center for Economic and Policy Research in Washington, D.C.

This article originally appeared on Economic Intelligence.

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