Volume 10, Issue 2, Spring 2000

Inequality in America: The Recent Evidence
Robert Z. Lawrence

For the period from 1979 through the early 1990s, the story is a very familiar one. Whether the data are arrayed by household, by earnings decile, or by indicators of skill and education, they all suggest two fundamental results. First, growing inequality: the more advantaged in the U.S. did particularly well while those at the bottom did poorly. Second, on average, workers fared poorly. Real wage growth was extremely sluggish and by some measures-such as average hourly earnings-actually declined over the period. These results were particularly striking in the face of two developments: the inequality trends had persisted despite (a) the long expansion of the eighties and (b) the relatively rapid increase in the supply of educated workers.

The literature advanced three lines of explanation for these developments: First, the force of globalization. The U.S. economy ran large trade deficits in the 1980s. In addition, there was a rise in the participation of developing countries in U.S. trade, partly occasioned by the shift in developing countries such as China to more outwardly oriented policies. It has been argued that these developments had particularly adverse effects on the demand for less-skilled U.S. workers, who were increasingly forced to compete with low-wage workers. In addition, the threats of outsourcing and increased international competition were said to reduce labor's bargaining power-a factor which was also held responsible for the slow rise in average wages. Immigration also contributed a larger number of less skilled workers.

Second, the force of technological change. It was also argued that there had been an acceleration in "skill biased" technical change. Computers and/or new management approaches emphasizing lean production skewed demand towards skilled workers and away from the less skilled.

Third, the force of institutional and structural changes. In the 1980s, de-unionization and deregulation weakened the power of workers. In addition, the declining share of employment in manufacturing reduced high-wage opportunities for blue-collar workers.

To be sure, these explanations are not mutually exclusive. Indeed they may be interrelated. International competition may have stimulated technological change. International competition has also been invoked to help explain the weakening of union bargaining power and the declining share of manufacturing employment. While economists differ on the relative importance of these forces-a majority arguing that technological change was dominant-most assign at least some role to all three. I'd like to examine what has happened in the U.S. economy since the mid-1990s. Let's ask first what has happened to these forces. Next let's look at the recent evidence on what has happened to various indicators of inequality, and then I'd like to reflect on what lessons we might draw.

The Forces at Work over the Past Five Years

First, what has happened on the globalization front? New trade agreements have been implemented-in particular NAFTA and the Uruguay Round. Trade has continued to rise as a share of the U.S. economy. In the aftermath of the Asian crisis, the U.S. trade deficit in goods and services increased dramatically. In addition, particularly since 1997, the prices of imported goods have fallen relative to the Consumer Price Index, and the prices of manufactured goods from developing countries, which are typically labor-intensive, have fallen even more rapidly than those from developed countries. By any measure therefore-trade agreements, trade volumes, trade prices, and trade deficits-globalization's forces were more powerful in the nineties.

Second, what has happened to technological change? One very powerful feature of the strength of this expansion has been investment in plants and equipment, particularly computers and information technology. This can be seen in the dramatic rise in the share of real investment in GDP and the share of high-tech investment in total investment, and, of course, the diffusion and development of the Internet. A second feature has been the heartening acceleration in productivity growth over the past three years. While productivity growth had been slow in the early part of this expansion, we've seen business sector productivity up 1.5 percent in 1997, 2.4 in 1998, and 3.0 in the year prior to mid-1999. Productivity levels are now well above the trend rate since 1973. By most measures of both inputs and outputs, therefore, the pace of technological change driven by the information revolution and other factors appears to have accelerated.

Third, what has happened on the institutional and sectoral front? Union membership has continued to decline in 1990s. Membership in the private sector has fallen by over 400,000 since 1994. The share of employment in manufacturing has declined steadily and, after rising through 1997, the number employed has fallen. In addition, welfare reform has added new workers, many with limited work experience, to the labor force.

In the light of these earlier explanations, most would surely have predicted even greater inequality in the 1990s, and a particularly tough experience for those at the bottom end of the income distribution. Yet that has not happened. Indeed, by numerous measures there has been no increase, and by some, inequality has actually been reduced.

The Recent Experience

Real wages and labor's share. Since 1995 we have seen significant increases in real wages. In addition, the share of output received by workers in the form of compensation has been rising since 1996. It shows almost no change over the longer run, suggesting that there has been no significant change in the shares of the pie going to labor and capital. There does not seem to be strong recent evidence that international competition has weakened labor's ability to bargain in this recent period. The most recent wage agreements concluded in the aerospace and automobile industries have been particularly strong.

College premiums. There has been no acceleration in the premium over the past five years for either men or women. The ratio of average weekly wages of college graduates to those of high school graduates had increased from 38 percent in 1979 to 74.3 percent in 1994, but between 1994 and 1998 it actually declined to 71.3 percent. A similar story emerges in data for average hourly earnings, although the hourly premiums are somewhat lower.

Earnings by decile. Over the past few years, the spread between the hourly earnings at the 90th percentile and those earning at the 10th percentile has stopped rising. The same story is evident in weekly earnings. Between 1979 and 1996 the ratio increased to 4.45. Between 1996 and 1998, however, it declined to 4.36. In the weekly data, likewise, the 90/50 spread also rose from 1.86 to 2.12 in 1996 and then subsided. An even more dramatic picture emerges in the hourly data in which we array the changes between 1994 and the first half of 1999. Here, when men and women are grouped together, we see increases that are highest at the bottom and lowest at the top. (They're up 8.6 percent since 94 in the lowest decile, up 4.7 at the top.) Similar images of faster growth at the bottom than at the top emerge for both men and women when the data are separated by gender. Thus the hourly earnings data actually indicate that there has been an increase in wage equality over this period.

More comprehensive indicators of inequality-income gains by quintile and an aggregate measure of inequality (the "Gini coefficient" for household income)-support the view that inequality has not increased. Since 1993, incomes have grown by between 9.9 and 11.7 percent for every quintile of the income distribution. After two decades of rising inequality the Gini coefficient measure showed no statistically significant change between 1993 and 1998. Here too, it appears as if the Gini is back in the bottle.

The least fortunate. The poverty data show excellent progress since 1994. The 1998 poverty numbers suggest poverty is lower than at any time since 1979. The poverty rate has fallen from 15.1 percent in 1993 to 12.7 percent in 1998. Over the last five years typical families have seen their incomes rise by 12.1 percent and African American families by 21.0 percent. Likewise, unemployment gains at the bottom are particularly impressive. Since 1993, African American unemployment has declined from 14.3 percent to 7.8 percent-the lowest on record-while Hispanic unemployment has fallen from 11.5 to 6.5 percent-also the lowest on record.

The overwhelming impression, therefore, is that the inequality has stopped rising. It is certainly incorrect to claim that we have actually reversed the drift towards inequality of the 1980s, and hard to make the claim that inequality is now on a downward trend-and some see trouble in that. But this is convincing evidence that inequality has not continued to worsen. And that is highly significant. It is important, therefore, that this new evidence be introduced into the discussion.

Searching for Explanations

How can we explain what has happened? Why is it that despite the apparent strength of these forces-globalization, technological change, and institutional and structural changes-the inequality outcome is not what might have been expected? There are both macroeconomic and microeconomic possibilities.

One obvious candidate is the role of the high-pressure economy and the associated low rates of unemployment. There is certainly compelling evidence that a high-pressure economy tends to increase opportunities for workers, particularly at the lower end of the scale. It may set in motion a positive virtuous circle in which new opportunities lead to new skills, higher productivity, and improved competitiveness, which in turn may allow for labor markets to be run at higher levels without upward pressure on wages. As the labor market tightens, there will be more opportunities and higher pay for those with fewer qualifications.

Ironically in this regard, forces which were seen as working towards increased inequality may well have contributed to allowing us to have a high-pressure economy. First, globalization and increased competition can lead to a onetime reduction in prices and margins which improves the short run inflation/output trade-off. Similarly price pressures may reduce profits and raise the relative share of labor. And lower import prices help contain inflation in the short run. In addition, when there is excess capacity in the rest of the world, we can draw on imports rather than strain domestic capacity utilization, again resulting in fewer price pressures. Second, as Alan Greenspan has emphasized, when we get positive shocks to productivity due to technological change, there is a powerful positive macroeconomic influence allowing firms to pay higher wages without them passing through into inflation.

A second possibility is that the trends themselves have been brought to a halt by offsetting microeconomic forces. Perhaps "technology" is responsive to relative wage costs. Skill bias does not come down from heaven but eventually shifts in response to incentives. Firms may increasingly find ways to employ relatively less well educated workers more effectively because these workers have become relatively cheaper. Or maybe the downward pressures from "trade" or globalization have run their course. In particular, the issue of substitutability between domestic and international production is relevant. It could be that eventually U.S. firms either are driven out of low-wage activities, or they figure out how to compete using competitive strategies which offset cheaper foreign labor costs. This means they no longer compete head to head with low-wage countries and thus are less affected by competitive pressures. Similarly, vulnerable unions may be forced to reduce members so that those who remain are actually the more powerful ones.

While the macroeconomic explanation implies that inequality could reverse in the face of higher unemployment, the microeconomic considerations suggest that we may have a more resilient economy. We may finally be reaping the benefits of having adjusted to some major structural challenges. But it is also possible that our explanations were defective in the first place, that we actually have never had a very firm grasp on what was shifting the trends originally. There were always problems with the story assigning a large role for trade. The numbers simply didn't seem to add up to anything big enough to explain a large share, and the other implications of the theories didn't seem to be corroborated.

There was also a problem with the skill-biased technology story. Why so much change and so little progress? Why in the eighties did we have changes in technology that were large enough to wrench the labor market and yet too small to boost productivity? Ironically, over the past five years we are getting the "progress," i.e., faster productivity growth, without the relative wage changes. Finally, credit for the differences in behavior should also be given to policy-on the macroeconomic front to both fiscal and monetary policy. The monetary authorities have been vigilant in avoiding inflation and yet willing and able to provide sufficient liquidity to finance non-inflationary growth and deal with financial crisis. Fiscal policy has been prudent with a long-run trend towards surplus, while at the same time resources devoted to education, training, and civilian technological development have been increased. As National Economic Council chief Gene Sperling has recently pointed out, strong deficit reduction has not hurt poverty reduction. Increased funding for the earned-income tax credit and for other education, training, and research has played a role. Important, too, have been increases in the minimum wage. Certainly this has raised wages at the bottom and it does not appear to have had a noticeably negative impact on the employment of the least well paid workers.

To conclude: We should not be complacent. We have not reversed the previous shifts towards greater inequality. Ideally we would like to see sustained gains for all and particularly large gains at the bottom. But we have made progress in arresting trends that were disturbing; overall these data suggest we have been doing the right things. In addition, it provides an optimistic message. We remain masters of our fate and are not, as some suggest, condemned to be buffeted by negative global or technological forces in the face of which we are helpless.

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