How much has the decline in the labor share affected income inequality?

Photo by Twixx, veer.com

Researchers have put a lot of time and effort into the search for the root causes of rising inequality. Technology, changes in educational levels, labor market institutions, and globalization are among the potentially important reasons why income inequality has risen in many countries over the past several decades. But if you’ve been paying attention to the debates about income inequality, you might realize that the kind of inequality being studied isn’t always the same.

Sometimes it’s the variance in wages earned by individuals. Sometimes it’s the declining share of labor. Or sometimes it’s the Gini index of household income. These measures tell us, respectively, about the distribution of labor income, the distribution of income between labor and capital, or the distribution of all income. So let’s say we’re ultimately interested in the distribution of all income. How much of this inequality is affected by changes in the distribution of labor income (wages and salaries) and how much is affected by a declining labor share?

Luckily, two researchers at the International Monetary Fund worked through the data to answer this question for recent decades. The working paper, by Maura Francese and Carlos Mulas-Granados, looks at the change in household income inequality in a number of countries—93, to be exact—from 1970 to 2013. The two economists break down how much of the rise in income inequality during this 43-year period was due to rising inequality within labor income (rising inequality of wages) and how much of it was due to income shifting away from labor to capital.

Francese and Mulas-Granados find that rising income inequality has been predominantly driven by rising wage inequality rather than a declining share of income going to labor. In other words, the change in the income distribution within labor was a much bigger factor than the change in the income distribution between labor and capital.

While the importance of these two factors will obviously vary among the countries Francese and Mulas-Granados examined, the authors also break out results for specific countries. In fact, their research shows that, in the United States, the declining labor share had no effect at all on rising income inequality from 1970 to 2013.

For those who think we shouldn’t be concerned about the decline in the labor share given these results, however, take a look at the years studied. The years between 1970 and 2013 show a number of different trends in income inequality. We only saw signs of a declining labor share in the United States until 2000, for example, but a decomposition of the factors affecting income inequality since 2000 might show a greater role for the labor share. At the same time, the analysis uses the Gini index as its measure of inequality. The Gini understates changes in tail-end inequality, so countries where inequality has been mostly at the top will appear to have less inequality to decompose. And finally the analysis assumes that changes in within-labor inequality and the changes in the labor share are independent. That might not be true.

Even then, the much larger importance of wage and salary inequality may still remain. While digging into the causes of the decline in the labor share is interesting and worthwhile, we should be keeping our eye on the inequality within labor.