Acemoglu: The Source of Rising Inequality

This NBER Reporter on technology and inequality by Daron Acemoglu is a few years old -- it's from 2003 -- but it's still very relevant. It pertains to the recent debate over the source of growing inequality and whether it is skill-based, or from other factors such as social norms and government policy.

As I've said before, unlike some who believe all of the notable change in inequality is driven by technology and changes in the returns to education, I think both technology and policy play significant roles. The section "Technology, Labor Market Institutions, and Social Norms" outlines one way for policy to play a role by linking technology to political and social factors driving inequality. The conclusion is that technological change can cause changes in the social and political environment that amplify the effect that technological change has on inequality:

Technology and Inequality, by Daron Acemoglu, NBER Reporter, Winter 2003: Many OECD economies have experienced sharp increases in wage and income inequality over the past several decades. ... Are new technologies -- in particular, computers, computer-assisted machines and robotics, and advances in communication technology -- responsible for these changes? ... Some economists now believe that, although other factors including the decline in the real value of the minimum wage, de-unionization, and globalization have played some role, the major driving force behind the changes in the U.S. wage structure is technology. ...

Although the consensus is now broad, the idea that technological advances favor more skilled workers is a 20th-century phenomenon. In 19th-century Britain, skilled artisans destroyed weaving, spinning, and threshing machines during the Luddite and Captain Swing riots, in the belief that the new machines would make their skills redundant. They were right... Products previously manufactured by skilled artisans came to be produced in factories by workers with relatively few skills, and many previously complex tasks were simplified, reducing the demand for skilled workers.

A major 19th-century technological advance, interchangeable parts, in fact was designed to be "skill-replacing" (un-skill-biased). Eli Whitney, a pioneer of interchangeable parts, described the objective of this technology as: "to substitute correct and effective operations of machinery for the skill of the artist..."

There are also no compelling theoretical reasons to expect technological change always and everywhere to be skill-biased. On the contrary, if replacing skilled workers is more profitable, new technologies may attempt to replace skilled workers... Even the most purportedly skill-biased technological advance, the microchip, can be used in scanners to complement unskilled work just as effectively as in personal computers to complement skilled workers. ...

Technology and the Recent Changes in Wage Inequality

There is general agreement among economists that technical change in the United States and the OECD over the past 60 years, or even over the past century, has been skill-biased. That is because the past 60 years have seen a large increase in the supply of more educated workers, yet returns to education have risen. In the absence of substantial skill bias in technology, the large increase in the supply of skilled workers would have depressed the skill premium... Of course here, "technology" needs to be construed broadly: it is not simply the techniques and machines available to firms, but also the organization of production, organization of labor markets, consumer tastes, and so on.

Many commentators in fact believe that there has been an acceleration in skill bias beginning in the 1970s or the 1980s. The most popular, but by no means the only, version of this hypothesis claims that there has been a notable acceleration in the skill bias of technology, driven by advances in information technology, or perhaps a "Third Industrial Revolution." ... Furthermore, during this time period the U.S. labor market also experienced a sharp increase in within-group inequality -- that is, inequality among similarly educated workers, which likely indicates the presence of some new and powerful forces. ...

Globalization and Inequality

Another major economic development of the past 30 years is the increased globalization of production.... A number of commentators have suggested that globalization and increased trade might be responsible for the rise in U.S. inequality. The arguments above -- that technological change has been important in the rise in inequality -- do not imply that other factors, such as globalization, have not played a major role. Nevertheless, most economists discount the role of globalization and trade for a variety of reasons. ...

Changes in the Organization of Production

The increase in the demand for skills and inequality in the U.S. economy may be as much attributable to the changes in the organization of production as to the direct effect of new technologies. Today's production relations, how jobs and monitoring are organized, and how firms recruit employees are all very different from 30 years ago. ...

An important driving force of the changes in production may be the increased supply of skills. When skilled workers are scarce, it is not profitable for firms to design their jobs specifically for skilled workers and to be extremely selective in their recruitment. In such a world, firms are often happy to hire many low-skill workers, train them, and employ them in relatively well-paid jobs. In contrast, in a world with many skilled workers, it pays to design jobs specifically for them and to be more selective in recruiting. This increases the productivity and pay of more skilled workers, and effectively excludes low- and medium-skilled workers from well-paid jobs.

Many of the developments in the U.S. labor market, including the recent trends in recruitment and human resource practices, the disappearance of middle-level-pay occupations, reduced training for low-skill employees, the greater dispersion in capital-labor ratios across industries, and the reduced mismatch between workers and jobs, can be explained by a theory based on an induced change in the organization of production and associated changes in recruiting strategies. Moreover, such an approach can explain the decline in the real wages of low-skill workers -- a phenomenon that pure technological theories have difficulty explaining -- because technological change, even when it is skill biased, also should increase the wages of low-skilled workers. With organizational change, though, resources will get shifted away from low-skill workers and jobs that paid them high wages will disappear.

Technology, Labor Market Institutions, and Social Norms

Emphasizing technology does not deny that changes in labor market institutions have been important. The erosion in the real value of the minimum wage and the declining role of unions undoubtedly have been important for changes in U.S. inequality, especially at the bottom of the wage distribution. In addition, the late 1980s and the1990s have seen an explosion in CEO pay, which is difficult to explain with changes in technology alone, and which suggests that there may have been concurrent changes in social norms pertaining to inequality and fairness. Why have labor market institutions and social norms related to inequality changed at about the same time that skill bias of technology accelerated? This may be a coincidence, or the overall changes in inequality may be the result of changing labor market institutions and social norms, and less the product of technology. In my view, a more fruitful approach is to acknowledge the independent effects of both changes in technology and changes in labor market institutions and social norms, and to link the two.

Recent research suggests how increases in inequality, for example attributable to technological advances, might affect labor market institutions and political preferences about redistribution. Similar arguments also might be used to link social norms of inequality and fairness to technology. Briefly, an increase in inequality might make it harder for certain labor market arrangements, like unions, to survive. Unions typically compress the wage structure, increasing the pay of less skilled workers at the expense of more skilled workers. An increase in the underlying inequality in the economy will make this more costly for high-skill workers, who then will withdraw from the union sectors and from unionized establishments.

Similarly, an increase in inequality may reduce the support that highly paid individuals give to the welfare state or to redistributive government programs. These considerations imply that technical change that increases the demand for skills can have much amplified effects on inequality, because it also will change labor market institutions and preferences towards redistribution. These forces might be amplified even more when technology also affects social norms, for example, as it becomes acceptable for CEOs to be paid much more than production workers.

Cross-country Differences

While inequality increased in English-speaking economies, there was much less of an increase in many continental European countries. To date, there is no consensus for why there was such a divergence in inequality trends among these relatively similar economies... Recent research suggests that labor market institutions compressing the structure of wages, as in many continental European economies, might induce firms to introduce additional new technologies to be used with their unskilled employees. Wage compression makes unskilled workers more expensive to employ and, conditional on wishing to employ them, it increases the value of raising their productivity.

Therefore, labor market institutions, such as binding minimum wages, union wage floors, and generous unemployment insurance programs, may have an amplified role in reducing inequality. They will do so directly and they will do so by encouraging technical change to be less skill-biased.

Overall, however, our understanding of the reasons for ... differences in inequality is weak, and much research is necessary on this topic...

I should note that Paul Krugman would not agree that the returns to education have increased in recent years, e.g. see here in particular, here, and here too, or his explanation in this email.

Comments

[Bruce Wilder]

I cannot help, but climb back on my favorite soapbox:

The argument from economists that income distribution is driven by technology rests on an extremely weak theoretical foundation, and, consequently, tends to be amorphous and naive. When the inevitable "more research is needed" conclusion is reached, I can only echo, you can say that again: both theoretical and empirical research.

To address the role of "skills" in the changing distribution of factor income, it is a theoretical necessity to have some model of how control works relative to the production process and output, and how changing control changes the roles and functions assigned to labor, and finally, how all that might affect wages in some state of general economic development and general labor supply/demand. That's a pretty long chain to model, and the failure to think deeply about *any* of it ought to be embarassing.

Acemoglu, at least, recognizes that changes in control paradigms and associated technologies and management organization has cross-cutting implications for wages. It has always been thus. The Lowell Mills, in 1816, were as near to "automated" as any factory, today, and the lovely young ladies earning their dowries in the new factories as machine tenders were paid relatively well, in an economy and society, which was not yet dominated by working for a money wage. Henry Ford's assembly line, in 1909, showed the way to much higher wages, but eliminated demand for a broad swath of skills.

Unlike in 1816 or 1909, the majority of Americans work in and for large organizations, at a money wage. Their bargaining position in relationship to those organizations, many of which are now dominated by men and women accustomed to massive, opportunistic thievery as the privilege of ultimate power, ought to be attracting more political attention that the abstract issues of technological determinants of income distribution. The slide of the Anglo-American hegemon back into kleptocracy is not a good trend.

[thlaylira]

Though, inequality, especially in todays technology sector, is only the beginning. I think that it is true, that there is much more disparity today between skilled and unskilled jobs in the computer sector thanks both to automation and technology changes. Take for instance Quality Support at many software houses over the last five years. We have seen a very significant shift from young college students and graduates to highly skilled spillovers from the dot.com bubble burst. Where these companies once helped groom future employees at this "mail room" level of the industry, we now find the desire for much higher automation, engineering, and development skills that even if these kids can demonstrate, are no match for the large pool of active-and-looking with much higher experience and education. Even that dreaded stalwart of the necessary help desk drone has been replaced by higher level techs as lower level tiers see the switch to automated solutions. The pay at these help desks have also steadily declined every year, again, one could argue, simply due to such a large supply of qualified (read overqualified) workers that are simply willing to "stoop that low" in order to support themselves and their families. A few years back Jacob Kirkegaard pointed out a very important fact in an article for the Institute for International Economics:

" If most of the jobs at risk of offshore outsourcing in the United States are low-paying jobs, the medium-term counter-factual to potential offshore outsourcing of such jobs might be elimination through technological automation. For example, the increased use and sophistication of automated responses in phone inquiries represents an obvious example of companies attempting to cut costs by resorting to the cheapest labor of all, namely computers, rather than perhaps outsourcing such services to a call-center in India--much of what can technically be outsourced today will in the end most likely be automated."

And it's true, especially at this level. Given the few times you have called technical support and reached a live employee, how many greeted you without an Indian accent? The same is happening at both development and quality assurance houses as well (and in some regards configuration management) as companies look first for high skilled laborers to set up an infrastructure that will soon replace them in this low position, only to be filled by lower skilled workers who are being aided by these automation solutions (whether it be the automated easy-answer phone systems, or the automated testing suites from companies like Mercury Interactive that help leverage employee testing time), and finally a way to have machines simply reduce the human cost completely and reduce the employee pool to a few techs. It's an interesting shift and I think it completely mirrors post-Fordism factory changes and the quality, and probably more so the inequality, of both the salaries and workers in the workforce. A very interesting and relevant topic.

[LVTFan]

With apologies for the duplication, I thought this expanded version of something written for another page on this site, would apply well here, too:

Over 125 years ago, an astute observer raised the question of why, in light of the awesome technological progress that had taken place in the first century since America's founding, there should be any poverty, much less the deep and widespread poverty that he saw in America's most developed cities.

He sought the explanation for that, and found it, and pretty well proved his case. All the benefits of technological progress, along with all the economic benefits that flow from our common investment in infrastructure (think of the Verrazano Narrows Bridge, or the Tappan Zee Bridge as two examples) and services (good schools, effective emergency services, to name two categories) accrue to the economic benefit of those who own our choicest land.

America's choicest land is not its agricultural land; agricultural land values range from a few hundred dollars per acre to perhaps $10,000 per acre in a few places (and perhaps more in wine grape climates). But urban land values in our healthiest cities can be as high as $250,000,000 per acre -- 100,000 times the value of a typical agricultural acre.

Who benefits from technological progress? The landholder. (Think of air conditioning and fiberglass boats. Think of elevators, or more precisely, elevator brakes. Land in the deep south would not be nearly as valuable in the absence of air conditioning; waterfront property, particularly on lakes and rivers would not be nearly as valuable in the absence of fiberglass boats; and urban land would not be nearly so valuable without elevators and subways and such.)

Where are all the benefits flowing? Landholders. REITS, family trusts, corporations. They get rich, not primarily from income from their buildings themselves, but from the locational value of those sites. But they didn't do more than you or I did to create that locational value.

Capital and labor can only share what's left after the landholder is paid his rent.

The alternative is to recognize land value as our common treasure and treasury, and collect it every month or quarter for the commons. The landlord would pass the land portion through in the form of a tax on land value. Then we could reduce what we collect on buildings, on sales, on wages.

Both labor (those who work) and capital (those who saved and invested in buildings, equipment, inventory) would benefit hugely were we to shift our tax focus this way.

Of course you might guess there are huge special -- landed -- interests who would not approve of this, which is why few of us -- even economics majors -- ever learned about these ideas.

But it aligns the incentives with where we want to go. Higher wages, more competition, lower barriers to entry, more jobs, ongoing redevelopment of the downtown, less sprawl, shorter commutes, less fuel usage, less time usage in commmuting, less pollution -- and a more equitable distribution of wealth, with wealth going to those who work, not those who "invested" in land, or whose gggrandparents "invested" in land. "Investing" in land does not add anything to the common wealth; it merely privatizes the commons.

"Investing" in land is legalized theft from all the rest of us. Let's shift the incentives to go in the direction we want to go.

For more on this, see http://www.wealthandwant.com/

[reason]

LVTFan
See my comment on your other post.