Why Has Inequality Been Growing?
How technology and winner-take-all markets have made the rich so much richer.
Vastly larger sums are at stake in many private companies. Consider a company with $10 billion in annual earnings that has narrowed its CEO search to two finalists. If one would make just a handful of better decisions each year than the other, the company’s annual earnings might easily be 3 percent—or $300 million—higher under the better candidate’s leadership. So if the top contenders for the CEO position are distinguishable with respect to the quality of the decisions they’re likely to make in office, then the competitively determined salary of the best candidate can be dramatically higher than that for the second best, even when the estimated difference in their talents is small.
Both the scale and scope of individual markets have grown enormously in recent decades. If one seller’s offering is better than all others, buyers from around the world now quickly get word of that fact. Lower shipping costs, coupled with falling trade barriers, have made it easier than ever to serve buyers everywhere. If an economic opportunity arises anywhere in the networked world, ambitious entrepreneurs are able to discover and exploit it more quickly than ever.
More intense competition has also been fueled by a significant increase in mobility. In the not-so-distant past, about the only way to become a CEO was to have spent one’s entire career with the company. With only a handful of plausible internal candidates, pay was essentially a matter of negotiation between the board and an individual who had no attractive prospects outside of the company. Increasingly, however, hiring committees believe that a talented executive from one industry can also deliver top performance in another.
A celebrated case in point was Louis V. Gerstner Jr. Having produced record earnings at RJR Nabisco, he was hired by IBM, where he led the computer giant, then struggling, to a dramatic turnaround in the 1990s. This new spot market for talent has affected executive salaries in much the same way that free agency affected the salaries of professional athletes in recent decades.
Greater competition also creates positive feedback effects that amplify the growth of salaries at the top. Such effects appear to help explain growing inequality among dentists, for example. Those whose earnings have grown most dramatically are often specialists in cosmetic dentistry, the demand for which has been fueled by higher top salaries in other occupations. And the highest paid dentists in turn often demand the services of the most highly paid specialists in other fields.
To be sure, the forces that have produced these changes have created important benefits for consumers. Tax software for the masses, for example, may have cost local accountants a lot of business, but it has also saved consumers an enormous amount of time and money.
Notwithstanding these benefits, the resulting growth in income inequality has exacted a high toll. Is there anything we can do to lessen it?
Tomorrow: Remedies for rising income inequality.
Robert H. Frank is an economics professor at Cornell University’s Johnson School of Management, an economics columnist for the New York Times, and a distinguished senior fellow at Demos. He is the author, most recently, of The Darwin Economy.