What are the links between institutions and shared growth?

Increasing inequality in the United States and its relationship to economic growth is getting a lot of attention lately. It is now clear that sharply rising inequality is not necessary for good economic performance and, indeed, growing evidence suggests that high and rising inequality is harmful, especially if the mechanisms generating the rise in incomes at the top of the ladder contribute to stagnant and falling incomes for the rest of us.

What matters most for the vast majority of American households is not inequality per se. Rather, individuals are mainly concerned with generating a higher standard of living via better wages and employment outcomes. Too many households confront a labor market in which it is increasingly difficult to find living-wage jobs. Despite substantial national productivity growth in the last 30 years, the average pre-tax income for the bottom 90 percent of American households was lower in 2013 than in 1980, and the wage for full-time male college graduates has not grown since the late 1990s.

This wage stagnation stands in contrast to the years following World War II until the late 1970s, when worker compensation grew in line with labor productivity. It’s true that compensation-productivity gaps have also appeared in other rich countries, but with one crucial difference—outside the United States this gap has increased despite substantial growth in worker compensation. While U.S. manufacturing workers have suffered from technology and global competition, that‘s also the case for manufacturing workers in all rich countries. For example, I’veshown that American manufacturing workers experienced a paltry 4 percent wage increase between 1980 and 2013 (after accounting for inflation) while manufacturing compensation increased by 42 percent in Germany, 43 percent in France, and 56 percent in Sweden.

Many argue that the United States makes up for poor compensation performance with strong employment growth. Yet over the past few decades, U.S. employment rates have not only beenlower than that of many European countries, but also have fallen dramatically in recent years—especially for men. In addition, while U.S. employment and GDP grew in tandem between the late 1940s and the mid-1990s, a yawning gap has developed since then, with GDP continuing upwards and employment flattening, despite a growing population.

In short, since the 1980s, U.S. economic growth failed to produce enough jobs, and equally important, enough “decent jobs, ” which I defined as those paying adequate wages with adequate hours of work.  Through my research—funded in part by a 2014 grant from the Washington Center for Equitable Growth—I am seeking to uncover the conditions and mechanisms through which economic growth gets translated into a sufficient numbers of decent jobs. More specifically, I aim to identify the institutions and public policies that help explain best practices for the creation of decent jobs.

What happened to shared growth? Most economists continue to explain the explosion of earnings inequality with conventional supply-and-demand stories, in which worker compensation is believed to accurately reflect the contribution workers make to production. Thus, in this view, CEOs and financiers have received skyrocketing salaries, especially since the mid-1990s, because they are now contributing dramatically more to their firms and to the economy as a whole.

Similarly, the bottom 90 percent have seen stagnant and falling wages because they’ve fallen behind in the “race between education and technology.” The computerization of the workplace requires greater cognitive skills, but workers have not kept up, as indicated by the slowdown in college graduation rates. Assuming (nearly) perfectly competitive markets, the explosion in wage inequality in this view must reflect a similarly explosive increase in skill mismatch (too many low skill workers, too few high skill ones).

Such arguments leave little or no room for labor market institutions and public policies in determining changes in the distribution of earnings up and down the income ladder. An alternative view is that institutionally-driven bargaining power is a critical piece of the story, whether it is the noncompetitive “rents” earned by top managers and financiers, or the collapsing power of hourly wage employees. As Thomas Piketty argues in “Capital in the Twenty-First Century:”

In order to understand the dynamics of wage inequality we must introduce other factors, such as the institutions and rules that govern the operations of the labor market in each society [and explain] the diversity of wage distributions we observe in different countries at different times.

All rich countries face challenges from technology and globalization, but only the United States and the United Kingdom show inequality rising to extreme levels.

In order to understand wage inequality and unshared productivity growth in the United States, we must take a much closer look at the ways in which institutions affect labor market outcomes. In my forthcoming research, I will compare the United States with Canada, Australia, Germany, and France to answer questions such as:

• How does the distribution and growth of decent jobs in these countries compare by economic sector, occupation, and demographic group?
• To what extent can these outcomes be attributed to the effects of differing institutions across the five countries?

Underlying this research design is the view that institutions matter a great deal for market outcomes. The United States can do a better job of generating decent jobs, and a sensible first step is to learn from the experiences of other countries.

This article is published in collaboration with Washington Centre for Equitable Growth. Publication does not imply endorsement of views by the World Economic Forum.

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Author: David Howell is a professor of economics and public policy at The New School in New York City

Image: A man walks down a corridor in Tokyo. REUTERS/Yuya Shino.