The Evolution of the Distribution of Individual Earnings in OECD Countries

1. Sydney February 2007 The Evolution of the Distribution of Individual Earnings in OECD Countries A B Atkinson, Nuffield College, Oxford and Paris School of Economics

2. Introduction • 1. Taking the Supply and Demand Story Seriously • Modelling the race between technology and education • Quantities and Prices • 2. Empirical Evidence about Earnings Dispersion • An augmented dataset on earnings for 18 OECD countries • Patterns of change • Enriching the Story • A Behavioural Model of Changing Pay Norms • Earnings at the top: superstars and managerial pyramids • Conclusions

3. Increasing decile ratio in the US 1980-

4. Were the 1990s a Pause or have we reached a Plateau? or ?

5. Textbook Story There is general agreement that the main factor behind the increase in the relative wage of skilled versus unskilled workers is a steady increase in the relative demand for skilled workers. (Blanchard, Macroeconomics, page 524). Globalisation: fall in relative price of goods in which unskilled workers are more intensively engaged. Technical progress biased in favour of skilled workers.

6. Relative wage of qualified workers ws / wu denoted by ω ● ● Shift in Demand Relative demand for qualified workers Ls/Lu

7. Missing • Dynamic story but dynamics not modelled. • Distribution of earnings depends on quantities as well as prices; cannot just look at wage differential. • “New” theories of labour market – Section 3. • Inter-relation between labour and capital markets. K Arrow and W M Capron, “Dynamic Shortages”, QJE 1958

8. Simple temporary equilibrium model At any point in time, supply of qualified workers is fixed at S and relative wage ω clears the market D[ω] = S Over time, demand shifts at exogenous rate g dlnD/dt = g – σ dlnω/dt (1) Supply adjusts according to premium over cost of acquiring education, which is assumed to be simply that of postponing entry to paid work by T years, r is the cost of borrowing dlnS/dt = β [ ω - e rT ] (2) Hence dlnω/dt = (β/σ) [g/β + e rT - ω]

9. dlnω/dt = (β/σ) [g/β + e rT - ω] β zero means pure rent, differential grows without limit β positive means convergence β infinite means pure compensating differential e rT Relative earnings g/β + e rT erT

10. Relative wage of qualified workers ws / wu ● ● + g/β erT Relative demand for qualified workers Ls/Lu

11. Casts doubt on criticism of the Skill Biased Technical Change (SBTC) hypothesis: “our main conclusion is that aggregate wage inequality has not risen continuously since the 1970s. … This suggests a potential problem for the SBTC hypothesis: why did the pace of SBTC slow down after an initial burst during the first few years of the microcomputer revolution?” (Card and DiNardo, JLE, 2002). • But Also: Wage premium depends on β, which may vary from country to country. • Wage differential may have increased because of rise in the cost of borrowing = inter-connection between labour and capital markets.

12. HOWEVER Distribution depends on Changes in Quantities as well as on Wage Differential • Kuznets model = model of quantity changes. • Societies becoming more educated = same kind of structural change. • (With constant wage premium) tends to shift Lorenz curve outwards at bottom and inwards at top. • ? Increase in dispersion among qualified workers ?

13. Increase in dispersion among the skilled Lorenz Curve Share of total earnings Effect of rise in ratio of skilled to unskilled in labour force SKILLED UNSKILLED P10 P 90 Share of total population

14. 2. Empirical Evidence about Earnings DispersionOECD View “ Gross earnings inequality has increased on average in OECD countries for which data are available. This occurred in countries where labour market performance improved considerably (Australia, the Netherlands), as well as in countries where it deteriorated (Germany, Hungary, Korea and Poland). Broadly unchanged wage dispersion was recorded in [France, Japan, Switzerland and UK]”. Assessing the Jobs Strategy May 2005

15. OECD comparison of 2000 and 1994 Decile ratio

16. Short time period • Series are not necessarily consistent over time • Looks at decile ratio, not bottom and top deciles separately • No clear metric: what constitutes a “rise”?

17. An Augmented Database • 18 OECD countries • Identifies breaks in series • Multiple sources for most countries

19. Metric • 1979/1980/1981 • versus • 1999/2000/2001 Five percent criterion for change to “count” P10 50 P90 180 DR 3.60 P10 47.5 P90 189 DR 3.98 Significant = increase of Ten percent or more

20. Change in Bottom Decile % 1980-2000

21. Rise in Top Decile % 1980-2000

22. Earnings deciles in the UK (1977 = 100)

23. All workers ■ FT adults ٭ FT non-managerial ○ WEE (for comparison) ∆

25. Summary of empirical evidence • Important to look separately at bottom and top deciles • 7 out of 18 saw fall in bottom decile of 5% or more from 1980 to 2000 • Majority ( 14 out of 18) saw rise in top decile; in 7 out of 18 rise exceeded 10% • In UK and US, decile ratio broadly stable since 1990 because rise in bottom decile offsets rise in top decile • Behaviour at top differs across countries. • Need to explain distribution among the qualified.

26. Enriching the Story • Two of many possibilities: • Behavioural pay model, with shift in pay norms (Atkinson, 1999) • Superstar rents and managerial pyramids at top

28. 100% E3 Jobs adhering to pay norm E2 E1 0 100% Belief about degree of acceptance of pay norm

29. 100% E3 Jobs adhering to pay norm E2 Firms with higher discount rates attach less weight to reputation E1 0 100% E1* Belief about degree of acceptance of pay norm

30. Superstar Theory(Alfred Marshall 1890s and Sherwin Rosen 1980s) + Gives role to both technology and trade - No direct link to distribution ? Explain earlier periods when top earnings fell?

31. Log (Earnings/median) Effect of trade and technology in expanding share of rents captured by top performers = fall in α Superstar model generates extreme value distribution with Pareto tail with exponent α Slope = 1/α Log [1/(1 – F)]

32. 7.2 Managerial Hierarchy Model (Lydall and Simon) β= loge[span of managerial control] divided by loge[1+ increment with promotion ] 25% increment span 5

33. Log (Earnings/median) Superstar model not enough on its own, since not explain earlier rise in α + - Hierarchical Salary Model Hierarchical model not enough on its own, since predicted Pareto exponent β too large Log [1/(1 – F)]

34. Not just a simple Race between Technology and Education • we have to study dynamics; there may be a temporary equilibrium with constant premium for qualified workers; there may be cobweb cycles. • Distribution depends on quantities as well as wages. • There has been widening of earnings dispersion in majority of OECD countries, but rises in decile ratio due more to changes at top than at bottom. • Need to take account of “new” theories of the labour market, such as behavioural models of pay norms. • Top earnings could be explained by mixture of hierarchy and superstar theories.