There is widespread agreement that inequality increased over the last several decades, but why that has happened is the subject of considerable debate.
- Is it because technological change reduced the number of good, middle class jobs?
- Is it the result of downward pressure on wages due to globalization?
- Can the changes be traced to the rise of “winner takes all” markets?
- Or is the decline of unions the main reason for the change in the distribution of income?
- What about the fall in the inflation-adjusted minimum wage, was that a factor?
- Did immigration have anything to do with it?
- How much of an impact did the reduction in income and inheritance taxes for those at the very top have on inequality?
- Should we focus mainly on differential educational opportunities between those at the top and those at the bottom, and the networking opportunities the top schools provide?
- What role did politics play in undermining unions, altering tax rates, resisting increases in the minimum wage, and failing to support educational initiatives that benefit the disadvantaged?
Some of these are easier to rule out than others based upon the empirical evidence. For example, there’s little evidence that immigration played a significant role in generating rising inequality. It’s probably the case that there are multiple causes of rising inequality rather than a single factor and that some of these factors interact. The decline in unions, for example, is related to the threat of offshoring in a globalized economy as well as political factors that undermined union authority.
But there is one factor, the presence of market power in both product and labor markets, that, in my view, does not get enough attention in this debate.
When markets are close to the perfectly competitive ideal that appears in textbooks, the profit that each firm makes is equal to the normal rate of return on investment (that is, in the language of economists, there is zero economic profit). When firms have some degree of market power, as most firms do, it is possible to earn profits over and above the normal rate. In such a case, the amount of money flowing into the firm is greater than what is required to keep the firm in business, and the question is how this excess “pot of money” is distributed within the firm. Should it go to owners, managers, or workers?
The answer depends upon who has the most bargaining power. In competitive labor markets where there are a large number of firms bidding for relatively homogeneous labor, firms do not have an advantage when bargaining with labor over wage rates. When firms have more power than workers do, as I’d argue they clearly do, then the “pot of money” that firms earn over and above a normal rate of return will end up in the hands of owners and managers instead of workers.
If workers had equal footing in such negotiations, or the advantage, then we would expect to see wages rising much faster than they have. The fact that we have seen inequality increasing at the same time unions have declined is at least circumstantial evidence that the decline in bargaining power of workers has something to do with the unequal distribution of income.
It also points to the solution. If the decline in bargaining power is an important factor behind the rise of inequality, then standard remedies such as more and better education for the working class is not going to solve the problem. It may help to overcome other reasons for rising inequality, for example technical change that increases the need for higher skilled workers in some industries, but it won’t do much to make it easier for the typical wage-earning worker to bargain for better pay. That will require an increase in the bargaining power of labor.
How can that happen? Improving unemployment compensation so that workers are not forced to take the first job offered at whatever wage they can get would help, as would an increase in the minimum wage. But the main thing that is needed is some sort of collective bargaining as existed when unions were able to provide “countervailing power” in wage negotiations.
Robert Reich has a list of proposals on how to do this, but in the present political environment, it’s hard to imagine the changes he suggests being implemented. It’s also hard to see how workers can bargain for a fair share of the economic pie without some type of change along these lines.
We could also take a stronger stand against the concentration of economic power in some industries. The Obama administration has been much better than the Bush administration on this front, but we could do a lot more to reduce the market power of cable companies, too big to fail banks, prescription drug manufacturers, airlines, agribusiness, and so on. Once again, that will be tough to do in a world where economic power translates into political power.
Many people confuse free markets with the textbook ideal of competitive markets. Markets that are free from government intervention are also free to accumulate a significant amount of market power. Rising inequality has more than one cause, and solving the problem will require us to attack on several different fronts. A good place to start would be for the government to take a much firmer stand against the economic power that firms have in both the product and labor markets.
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