Explaining Inequality

Is technological progress behind growing income inequality? Zsolt Darvas argues increased automation is only part of the explanation.

There is a growing awareness that income inequality has increased in a number of developed countries. The lucky ones, with high levels of accumulated wealth, assets and top incomes, earn more and more, while those who are at the bottom of the income distribution increasingly see little opportunity for increased spending, buying a house of their own, or going to nice destinations for their holidays.

One possible explanation for these widening inequalities is technological progress, which may reward skilled workers more in comparison with unskilled workers. This idea sounds intuitive: those with higher skills, such as IT developers, are able to generate a great deal more output thanks to new technologies, and so they receive the proportionate remuneration . In contrast, those with lower skills, such as waiters, cannot generate much more value using new technologies and therefore do not receive extra compensation.

What is more, robots are replacing certain types of human labour altogether. Some jobs are more easily robotised than others, but certain low-skilled or routine tasks are the most easily automated. These workers risk finding themselves out of employment.

Globalisation may add a further twist. The immigration of low-skilled workers, a widespread phenomenon in many developed countries, may dampen the wages of local low-skilled workers by increasing the labour supply. Furthermore, offshoring production to low-wage emerging countries, as well imports of goods from these emerging economies, may supplant local jobs and further dampen the wages of local low-skilled workers.

So runs the argument. However, our recent research casts doubt on the hypothesis that technology-driven developments were a major factor behind rising inequalities in advanced countries.

Let me start with some facts about jobs. Both the European Union and the United States are characterised by strikingly similar labour force developments. In both regions, there has been a decline in the number of jobs for workers with low levels of educational attainment over the past 25 years. Meanwhile, there has been a tremendous increase in jobs for workers with tertiary education, and this is the only job category that expanded after 2008, even in several countries that were hit hard by the recent global and European financial and economic crises. While underemployment, when a worker takes a job for which they are over-qualified, is a prevailing phenomenon, it tends to be temporary.

If a greater share of jobs are only open to tertiary-educated workers, it could contribute to increasing inequality, if tertiary-educated workers earn ever more, relative to lower educated colleagues. Data shows that this has been the case in the United States and China, and to a much more limited extent in Germany. However, exactly the opposite has happened in many other countries during the past two decades, including the United Kingdom, Italy, Spain, France, Sweden and Japan. In these countries the so called ‘skills premium’ has actually fallen.

So, what can explain this divergence in wage developments for tertiary-educated workers between the United States and most of Europe, when the market of available jobs developed so similarly? One possible explanation could be the supply of workers: if there is a shortage of certain types of workers, their wages go up. But such labour shortages do not provide a sufficient explanation, since the number of new graduates increased at the same rate at both sides of the Atlantic.

Moreover, a statistical relationship can be established between the share of tertiary-educated workers and their wages relative to lower-educated peers, and also between the unemployment rate of tertiary-educated workers and their pay rises. The United States is an exception to both of these statistical observations: its relatively high share of tertiary-educated workers is associated with a relatively high skills premium, while the wage growth of tertiary-educated workers was much faster than what their unemployment rate would have implied.

Clearly, something special was going on in the United States, which contributed to the rising rate of compensation of tertiary-educated workers, which in turn boosted income inequality. Technological progress cannot really be an explanation, since technology also impacts Europe, but most European economies saw a relative wage decline of tertiary-educated workers. That is, the skills premium actually fell in most European countries. Also, job offer developments for high- and low-educated workers were so similar across the Atlantic, and technology likely played a role in this, but wages were on very different trends.

Instead, the explanation may be related to public policies and the formal protection of certain occupations. In the United States, a rather small fraction of the top one per cent of earners comes from high-tech industries such as ICT and manufacturing. The bulk of top earners are lawyers, doctors, dentists and financial sector professionals. Some of these industries enjoy a relatively high level of protection, while the impact of technological change may still be comparatively modest. Europe tells a different story. In many European countries, a much higher share of the top one percent of earners than in the United States is in the manufacturing sector.

Public policies, such as redistribution, education and labour market policies, may also play a role. Redistribution from the rich to the poor is at a much lower level in the United States than in Europe. Certainly, the national redistribution system could be made more effective in a number of European countries, but overall redistribution and social protection is much stronger in the EU.

Therefore, even though our analysis suggests that technological change tends to favour those with greater skills, it is hard to see how this has contributed to rising inequality. Other factors such as redistribution and education policies or the regulation of certain professions may be more relevant.

In any case, a new machine age is in the making, and ever more jobs will be replaced by automation. If technology is able to begin dealing with non-routine cognitive tasks, then the next generation of workers must be equipped with skills that benefit from technology rather than being threatened by it. Such skills are likely to emphasise social and creative intelligence. Appropriate shifts in education policy are therefore surely required in order to meet the challenge of technological development.