The rise of inequality in advanced economies, and in particular the growing concentration of incomes at the top of the distribution, has become a greater focus of attention for economists and policymakers. Understanding the factors behind this phenomenon is essential to determine whether policy action is needed to reduce income inequality, taking into account other policy objectives. Traditional explanations advanced for the rise in inequality have been technological progress and globalization. But there is little policymakers are able or willing to do to reverse these trends, because they benefit growth. Moreover, while high-income countries have been similarly affected by technological change and globalization, inequality in these economies has risen at different speeds. This has led economists to underscore the role of institutional changes, notably of financial deregulation and lower top marginal personal income tax rates.
This paper takes a fresh look at the causes of the rise of inequality in advanced economies, focusing on the relationship between labor market institutions and the distribution of incomes—which has featured less prominently in recent debates. We find evidence that the erosion of labor market institutions is associated with the rise of income inequality in our sample of advanced economies, notably at the top of the income distribution. Our key findings are that the decline in unionization is related to the rise of top income shares and less redistribution, while the erosion of minimum wages is correlated with considerable increases in overall inequality. There is also some evidence that the broad extension of collective agreements to non-union members is associated with higher inequality, likely owing to higher unemployment. Finally, we confirm that financial deregulation and lower top marginal tax rates are related with higher inequality.
The most novel result is the strong negative relationship between unionization and top earners’ income shares. This finding challenges preconceptions about the channels through which union density affects income distribution. Indeed, the widely held view is that changes in labor market institutions affect low- and middle- wage workers but are unlikely to have a direct impact on top income earners. We argue that if de-unionization weakens earnings for middle- and low-income workers, this necessarily increases the income share of corporate managers and shareholders. The channels through which weaker unions could potentially lead to higher top income shares include the positive effect of weaker unions on the share of capital income—which tends to be more concentrated than labor income—and the fact that lower union density may reduce workers’ influence on corporate decisions, including those related to top executive compensation.
While our findings, if interpreted as causal, suggest that higher unionization and minimum wages can help reduce inequality, they do not constitute a blanket recommendation for more unionization or higher minimum wages. Other dimensions are clearly relevant. Unions, if they primarily represent the interests of some workers, can lead to high structural unemployment for some other groups, such as the young. Minimum wages can be too high and lead to high unemployment among unskilled workers and loss of competitiveness. Deciding whether labor market institutions are appropriate needs to be done on a country-by-country basis, taking into account other policy objectives, including macroeconomic stability, competitiveness, growth, and unemployment. Finally, our results support a multi-pronged approach to addressing the increase in inequality, including tax reform and curbing excesses associated with the deregulation of the financial sector.
Chosen excerpts by Job Market Monitor. Read the whole story at IMF Survey : IMF Staff Paper: Linkages Between Labor Market Institutions and Inequality.