Income inequality has risen in most OECD countries over the past three decades. A simple way to capture this is to look at the change in the share of labour income going to the top 10% of the income distribution. Across our selection of large developed countries, there has, on average, been a 4.5 percentage point (ppt) increase in the share of labour income going to the top 10%. The largest increase in inequality has taken place in the US, where skyrocketing CEO and financial sector pay coincided with a long period of stagnation in median incomes.

 

 

Some researchers have argued that automation and computerization have helped push down both the labour share of national income and the share of income going to workers in the lower parts of the income distribution.

 

There is also evidence that technological change has altered the distribution of labour income. According to this view, the technological changes that have occurred in recent decades have been biased in favour of high-skill workers with jobs that cannot be easily automated.

 

Another phenomenon that appears to be putting downward pressure on labour incomes in the developed world is globalization. Not only have global trade flows increased much more quickly than global GDP, but the emerging markets’ share of global GDP and trade has increased substantially. Indeed, in just the last decade, their trade share has increased from 40% to 50%, with China now the world’s largest exporter of manufactured goods.

 

The key channel through which globalization affects labour income shares and inequality in the developed world is via the surge in the effective global supply of low and medium-skilled labour. As a billion Asian workers have been added to the global market economy, the developed economies have been losing their comparative advantage in the production of low and medium-skill intensive traded goods. This has forced down the price of labour and encouraged firms in developed countries to offshore production to the emerging world. In essence, the rise of labour in emerging markets has come partly at the expense of labour in the developed countries, and particularly manufacturing workers.

 

Another factor that may be weighing on income shares and aggravating inequality is a reduction in the bargaining power of labour in some countries. Trade union density has declined in all but four of the 32 countries in the OECD over the past decade.

 

The bargaining power of labour also has a cyclical dimension. In the wake of recessions there are a larger number of unemployed workers chasing fewer jobs. That in turn puts downward pressure on wages and tends to push down the labour share of income. It can also lead to higher income inequality as lower skilled workers are more likely to lose their jobs and have less bargaining power over their wages.

Looking forward, we expect the economic recoveries taking place in most countries to generate a modest increase in labour income shares as unemployment falls away. That implies that the corporate profit share of income should not fall far. The outlook for income inequality appears bleaker.

 

With market forces unlikely to generate a more favourable distribution of income, voter clamour for more direct redistributional policy interventions could increase. If this occurs, governments should keep in mind that they are best pursuing policies that have the double dividend of lowering inequality and boosting economic growth.

 

For example, earned-income tax credits, other well targeted fiscal transfers and active labour market policies all strengthen the incentives to work, or rewards from employment, and are therefore more likely to have a positive growth trade-off than sharply raising marginal income tax rates or strengthening employment protection.

 

Slower acting but equally important are educational policies that raise the human capital/skills of lower income workers and disadvantaged young people so that they can better compete in the global labour market. Such policies should boost economies’ potential growth rates, expand the overall profits base, and therefore be positive for risk assets. If on the other hand governments pursue less market friendly interventions that distort labour markets, product markets and global trade, then the consequences for longer term growth and wealth accumulation are likely to be poor.