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Technological change helps explain the diminished role of labor in the economy. The price of investment goods for firms (like computers, machinery, and so forth) has been falling even as the capabilities of these machines improve. This has caused an increased demand for machinery relative to workers.
These technological shifts in the role of labor also help explain the increasing income inequality of the past few decades. There is a strong pattern of increasing rewards to education in the data. Earnings are rising only for those with a lot of education—workers whom technological change makes more productive rather than redundant (figs. 2.8 and 2.9).
For American workers to benefit from technological change, their skill set must keep pace with changes in the economy. Unfortunately, progress in US educational attainment has fallen short of progress in technological innovation. In earlier decades, US educational attainment increased steadily, at a rate of 0.8 years of education per decade between 1890 and 1970. While less than 10 percent of Americans graduated from high school in 1890, by 1970 that portion had risen to 80 percent.16 Since then, American educational attainment has increased more slowly; the most recent statistics show high school graduation rates only slightly above their 1970 levels, at 83 percent in 2015. (That was after five consecutive record-setting years; the rate a few years earlier was unchanged from its 1970 level.)17
US students lag behind those in other countries in terms of both high school graduation rates (ranking twelfth among a group of rich countries) and college graduation rates (ranking eleventh).18 In the 2015 international PISA tests, US students were ranked thirty-seventh in math, twenty-fifth in science, and twenty-third in reading.19 This inability of US educational attainment to keep pace with technological progress has likely been a large contributing factor in the woes of middle-class workers. For a subset of workers, technological change makes them more productive. But for another subset of workers, technological change is a threat, as machinery and robots displace the demand for workers. This problem will be further described in Chapter 4.
Figure 2.8: Earnings Rise with Education (Men)
Source: David Autor, “Skills, Education, and the Rise of Earnings Inequality among the ‘Other’ 99 Percent,” Science 344:6186 (2014): 843–851. Reprinted with permission from the American Association for the Advancement of Science.
Figure 2.9: Earnings Rise with Education (Women)
Source: David Autor, “Skills, Education, and the Rise of Earnings Inequality among the ‘Other’ 99 Percent,” Science 344:6186 (2014): 843–851. Reprinted with permission from the American Association for the Advancement of Science.
Trade and Global Competition
In recent decades, there have been large increases in global trade and investment flows. Political decisions made by foreign countries were the key driving force in these trends. Countries that had been more closed to international trade joined the world trading system, increasing trade flows. The number of World Trade Organization (WTO) members, for example, increased dramatically. (The WTO is an organization that facilitates international trade treaties, working to liberalize trade.) Membership expanded from 18 members at inception, to 84 members in 1980, to 164 members today (fig. 2.10).20
Also helping to fuel increasing trade have been falling communication and transportation costs. The greater access to information afforded by computerization and the Internet makes it far easier to do business across borders. Technological changes have also enabled global production processes, by solving the complicated logistical puzzles of global supply chains. Finally, economic growth abroad has also increased international trade flows, which tend to increase with the size of the economy.
For the United States and more broadly the world, the importance of trade in the overall economy has grown by about 50 percent relative to its level in 1980. Both then and now, the rest of the world is about twice as globalized as the United States (fig. 2.11). Foreign countries rely on international trade to a greater extent due to their smaller domestic economies.21
Figure 2.10: More and More Countries Join the World Trade System
Data source: World Trade Organization.
Figure 2.11: Trade is Increasing, But the United States Trades Less Than the World
Data source: World Development Indicators, World Bank.
International investment flows have also increased, both in terms of portfolio investments (people and institutions purchasing foreign stocks, bonds, and other assets) and foreign direct investments (companies purchasing other companies or undertaking new investments abroad). Here, the United States is as globalized as the world as a whole.
Of course, foreign investment goes in both directions, and the United States receives amounts of inward foreign direct investment (by foreign companies investing here) similar to what it sends in outward foreign direct investment (when US firms invest abroad). Both types of foreign direct investment are increasing over time (fig. 2.12).
In general, these flows of foreign direct investment understate the role of multinational firms in the world economy, since they capture only changes in investments from year to year, not the size or importance of global firms. By most indicators (sales, profits, assets, or market capitalization), multinational firms have become steadily more important in recent decades.22
Net migration flows have been steadier for the United States. That said, the share of the population that is foreign-born has been climbing in recent decades, and now stands only a bit lower than it was during a previous peak era of immigration, around the beginning of the twentieth century (fig. 2.13).
International trade, international capital mobility, and international migration are all chief suspects in the search for a culprit to blame for poor US labor market outcomes. For example, since trade with developing countries has increased particularly rapidly, and these countries have large, low-wage labor forces, this may increase competition facing US workers, lowering wages. Competition from low-wage countries may also encourage US firms to innovate in order to economize on labor, accelerating the adoption of technology that replaces labor with machinery.
Figure 2.12: Foreign Direct Investment Flows Are About Three Times Their 1980 Levels
Data source: World Development Indicators, World Bank.
Both foreign direct investment and immigration could also bear some responsibility for the woes of US workers. If immigrants are more likely to compete with workers at the bottom of the income distribution, that could reduce wage growth for those workers, exacerbating income inequality (though there are also many ways in which immigration helps workers, as discussed in Chapter 8). The international business operations of global corporations likely reduce the bargaining power of labor and labor unions, as companies may use the threat of moving abroad to restrain wage growth at home. And if some types of operations are systematically moved abroad, that reduces demand for those types of workers at home.
Figure 2.13: Immigrants are Increasingly Important, But Still Less So than in Early 1900s
Data source: Migration Policy Institute.
Still, puzzles remain. First, in poorer countries, income inequality is also increasing alongside reductions in the labor share of income.23 That is counter to expectation, since integration with the world economy should be increasing demand for workers in poorer countries. It could be that technological change is the dominant force throughout the world, increasing demand for machinery and higher-skilled workers relative to less-skilled labor. Indeed, computers, the Internet, and broader technological change have affected the entire world economy.24
Another puzzle concerns how much income has been concentrated at the very top of the income distribution, among the top 5 percent, the top 1 percent, and even the top tenth of 1 percent. Neither trade nor technological change does a good job explaining the huge gains in income at the very top of society. Trade should increase demand for the products of our export industries, while reducing demand for import-competing industries; while such demand shifts shoul
d move income across broad groups of people, they should not concentrate it at the very top. Similarly, technological change should harm those whose labor is replaced by technology, while helping those whose productivity is boosted by technology. Again, as these changes affect broad groups of people, there is no reason to think the gains should be concentrated at the very top of society. The next four items do a better job explaining what is happening at the top end of the income distribution.
The Role of Superstars
The superstars at the top of the income distribution reap outsized rewards. Top investment bankers, information technology entrepreneurs, corporate CEOs, hedge fund managers, and corporate lawyers occupy plum spots in the top 1 percent, as do household names in entertainment and sports like Beyoncé and LeBron James. These labor markets have characteristics of “superstar” or “winner-take-all” compensation patterns; those at the top receive salaries that are many multiples of those a bit lower in the distribution.
As an example, consider America’s favorite pastime, baseball. In 1970, the average major league baseball player earned $184,000 in 2017 dollars. Now, the typical major league baseball player earns over twenty times as much, $4.5 million dollars. Salaries have climbed especially steeply since the 1980s (fig. 2.14).
Yet, while being in the major league pays well, being slightly less talented pays terribly. Minor league baseball players typically earn $1,200–$3,000 per month for a five-month season, with no pay for spring training. If they only played baseball for a living, they would live under the federal poverty line!
Similar trends hold in music, with greater shares of revenues captured by the most popular artists. The top 1 percent of artists took in 26 percent of all concert revenue in 1982, and by 2003 commanded 56 percent.25
Both globalization and technical change buttress the superstar effect, turbocharging the relative earnings of the stars. The combination of larger world markets and the ease of digitizing and distributing information creates big paychecks for the most productive (or lucky) talents in society. The best entertainers and athletes earn premium returns, since their talents are now accessible to their fans throughout the world, who can watch videos and sporting events remotely. This increases the size of the entertainment sector.
Figure 2.14: Average US Major League Baseball Salary, Twenty-Three Times Higher in 2017 than in 1970
Data sources: US Bureau of Labor Statistics; Paul D. Staudohar, “Baseball’s Changing Salary Structure,” Compensation and Working Conditions, Fall 1997; http://hosted.ap.org/specials/interactives/_sports/baseball08/documents/bbo_average_salary2009.pdf.
Slightly lesser talents (or less lucky ones) often earn far less, however, than those at the top. Less renowned singers and ballplayers (and businesspeople) face increased competition from other talented people across the world. They also face the increased costs associated with paying the superstars. The princely pay packages of superstars squeeze pay for the less talented. Some superstar returns also accrue to capital, as the investors and producers that control the ownership of talent are amply rewarded.
Similar mechanisms are at work in terms of entrepreneurial or corporate returns. The makers of the best search engines, phones, and social networking sites can sell their products all over the world, benefiting from the scale allowed by the world economy. The best hedge fund managers command ever larger pots of investment capital, and earning “2 plus 20” becomes an enormous sum. (Hedge fund managers often charge 2 percent of asset value as a management fee and also receive 20 percent of earned profits.)
Since someone must pay for these outsized rewards, that leaves less national income for the less successful versions of these entertainers, athletes, managers, or entrepreneurs. Being a 90th percentile talent in these fields can pay orders of magnitude less than being a top talent. And increased competition means that very few become superstars.
The Rise of Profits
A closely related issue has to do with the excess (above normal) profits that arise from entrepreneurial and corporate success. The world economy provides large rewards to the most successful and innovative entrepreneurs and businesses; these profits play an important role in labor market trends.
It is tempting to label these profits as the just desserts of ingenuity and innovation, or the economic “carrot” that offers incentives for risk-taking. To be sure, the creators of Apple Computer, Microsoft, Google, and Facebook have changed the way we use computers and the Internet, benefiting billions of people. Yet for every Bill Gates and Mark Zuckerberg, there are tens of thousands of technology talents that have contributed to this industry, and despite very similar levels of ingenuity and hard work, have not become even a thousandth as rich.
Alongside entrepreneurial profits, there is substantial evidence of increased market power for many large corporations. In parallel with declining labor shares of income, there have been large and pervasive increases in corporate profits and retained earnings of corporations.26 In the United States, corporate profits since 2000 are about 50 percent higher as a share of GDP than they were in the previous twenty years, and corporations are responsible for more and more of the total savings of our society.27
As compared to 1980, corporate savings have come to constitute a much larger share of total savings. Globally, since that year, corporations’ share of total savings has increased by about thirty percentage points (fig. 2.15).28 This staggering increase is mirrored by a declining share of global savings in the hands of households. Why are corporations doing more of the saving? Simply put, they are earning more of national income, as the capital share of income is rising relative to the labor share of income in most countries.
These trends are related to the troubling issue of secular stagnation: rising corporate profits and changes in the distribution of income have increased savings, but investment opportunities are declining—which reduces economic growth. In the meantime, corporations are awash in cash.29
While we expect all businesses to earn some “normal” level of profit to justify their efforts, excess profits (above the normal rate) are now the norm in the US corporate sector. In the United States, the share of corporate earnings that represent excess profits is over 75 percent.30 This is not just an American phenomenon. Worldwide, the corporate sector is getting more concentrated, and large companies are dominating in terms of profits, sales, and scale. The top 10 percent of the world’s public companies earn 80 percent of the profits, and companies with more than $1 billion in revenues account for the vast majority of all global revenues and market capitalization.31 And because these superstar companies use less labor than typical companies, so as the dominant companies account for more of all economic activity, the labor share of income falls.32
Figure 2.15: Globally, Corporate Savings Are Now About Two-Thirds of All Savings
Data source: Peter Chen, Loukas Karabarbounis, and Brent Neiman, “The Global Rise of Corporate Saving.” NBER Working Paper 23133 (2017).
Bargaining, Power, and Norms
At the same time that corporate profits and power have become more important, the role of labor unions has shrunk, and worker bargaining power is steadily weakening. In the United States, the unionization rate has fallen from 31 percent in 1960 to 11 percent today. Focusing particularly on private-sector unionization rates, the fall is even greater; now, only 7 percent of private sector employees are unionized. Abroad, the average unionization rate for workers in peer countries was 35 percent in 1960, and fell to 17 percent by 2014.33 These falls in unionization have important effects on labor markets; unions have historically played an important role in narrowing income inequality.34
The sources of declining unions are various. Right-to-work laws, which make it more difficult to have effective unions, have spread to twenty-eight US states, up from nineteen US states that had right-to-work laws in 1980.35 The decline of the manufacturing sector plays a role, too, since manufacturing jobs are more often unionized. Meanwhile, the dual threats of global competit
ion and technological innovation do their part to weaken labor bargaining power.
Other factors also affect labor. The real value of the federal minimum wage has hovered near its current level in recent decades, but it was higher (in inflation-adjusted terms) in the 1960s and 1970s. Shifts in social norms have reduced the bargaining power of labor relative to management. As one example, American Airlines recently tried to give its workers raises to match pay offered at other airlines, but its stock price was punished as a result.36 Investor pressures make it more difficult for labor to succeed in wage negotiations.
While both globalization and technological change have contributed to the erosion of labor bargaining power, they are clearly not the only factors at work. Industries like trucking have experienced similar pressures, yet they are largely immune from foreign competition and from labor-replacing technological innovation (so far). For example, the real wages of truckers and warehousing workers have fallen by a third since the early 1970s; the Bureau of Labor Statistics estimates that drivers were paid 6 percent less, on average, in 2013 than they were in 2003. Plummeting salaries are the product of dramatic changes in union membership, from a 38 percent rate of driver unionization in 1983 to a 13 percent rate in 2016.