Why Have Levels of Income Inequality Risen So Much?

The recession has been tough on many Americans.  But the recession only started in 2008, and the statisticians at the National Bureau of Economic Research figure it ended in 2009.  The recession was pretty short.

No, the problems in America’s realonomy have been a long time in the making.  Median incomes in America have been stagnant since 1973.  You can’t blame that on the recession.

Total US national income per person has more than doubled over the past forty years (adjusting for inflation).  Why then have incomes for most Americans been stagnant or falling?  Why do American families now need two incomes to have the standard of living they used to have with just one?

Why aren’t today’s young adults making twice as much as their parents did were when they first entered the labor market thirty years before?

The answer is that all of the growth in the American economy over the past forty years has gone to the top 50% of American households.  Most of it has gone to the top 20%.  In recent years, it’s gone to the top 1% only.

In other words, the US income distribution has become much less equal.

If the US income distribution today had remained unchanged over the past thirty years, the average American household would have a total income over $85,000.  Instead it’s around $50,000.

[pullquote]If the US income distribution today had remained unchanged over the past thirty years, the average American household would have a total income over $85,000.[/pullquote]

If the US income distribution had become more equal in the four decades after 1970 — as it did in the four decades before 1970 — the average American household would be doing even better.

The fact that the average American household today has an income of $50,000 instead of $100,000 can be attributed entirely to the fact that inequality has risen over the past four decades instead of declining.  America has far greater income than ever before in its history, but that income is concentrated in fewer and fewer hands.  Rising inequality is killing middle America.

It’s no mystery why inequality has been rising in America.  As a recent 11-country comparative study concluded, the main factors that determine whether a country is equal or unequal in its income distribution are “union density, the strictness of employment protection law, unemployment benefit duration, unemployment benefit generosity, and the size of the minimum wage.”  (Winfried Koeniger et al “Labor Market Institutions and Wage Inequality,” Industrial and Labor Relations Review, Vol. 60, pp. 340-356.)

By far the most important of these factors is union density, the percentage of workers who are covered by a union contract or collective bargaining agreement.

Around the world, wherever workers have unions, they get better pay.   The most recent estimates suggest that unionization increases an individual worker’s pay by about 17%,  but some argue that the effect on total pay (including benefits) could be as high as 43%.

The key issue is bargaining power.  Obviously, workers who bargain as part of a union are in a better bargaining position than workers who don’t have a union.  But it’s not just a matter of unions.

Where unemployment benefits are generous, workers can bargain harder, since it’s not catastrophic if they lose their jobs.  And having a good minimum wage means that when unemployed workers run out of insurance payments they can be sure of earning at least a living wage when they do go back to work.

One way to reduce inequality is to tax the rich and give to the poor.  Another is to make the poor more powerful so they can negotiate better deals from the rich.  Both are necessary.  For forty years, America has done neither.

And so the average American family lives on $50,000 a year instead of $100,000, while a few not-very-average American families garner huge wealth that goes largely untaxed.

That’s why US levels of income inequality have risen so much for so long.  We’ve let them.  If we reversed the pro-rich policies of the past forty years, income inequality would fall — rapidly.

The problem is not a failure of our economy to support the American people.  The problem is a failure of our democracy to support the American people.  We have only ourselves to blame.