How Technology and Winner-Take-All Markets Have Made Income Inequality so Much Worse

Commentary about business and finance.
Dec. 6 2011 7:16 AM

Why Has Inequality Been Growing?

How technology and winner-take-all markets have made the rich so much richer.

The first part of this series described how growing income disparities have made it more expensive for middle-income families to achieve many basic goals, such as sending their children to a decent school. Today’s installment discusses the forces that have caused income disparities to grow in recent decades. This essay is adapted from Robert H. Frank’s recently published book, The Darwin Economy.

Michael Jordan
Rewards tend to be concentrated in the hands of a few top performers

Photograph by Jeff Haynes/AFP/Getty Images.

Robert H. Frank Robert H. Frank

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.

Effective remedies for growing income disparities require a clear understanding of the forces that have caused them. In their recent book, Winner-Take-All Politics, Jacob Hacker and Paul Pierson have argued that explosive salary growth at the top has been fueled by a more lax regulatory environment purchased with campaign contributions. That’s a spot-on description of what happened in the financial services industry, which is of course the principal target of the OWS movement.

But it’s an unsatisfactory account of why inequality has been rising in other occupations. The same pattern of income growth we’ve seen for the population as a whole has been replicated for virtually every subgroup that’s been studied. It holds for dentists, real-estate agents, authors, attorneys, newspaper columnists, musicians, and plastic surgeons. It holds for electrical engineers and English majors. And in none of those instances has it been primarily the result of regulatory favors.

To be sure, executives sometimes pack their boards with cronies who reward them with exorbitant salaries and bonuses. But such abuses are no worse now than they’ve always been. On the contrary, improved communications and falling transportation costs have almost certainly made them less serious. Executive hiring committees may not be perfectly informed, but they have more information than they used to, and this makes reputation a more effective predictor of performance. Similarly, increased vigilance from institutional shareholders and growing threats of hostile takeovers have placed additional constraints on executive pay abuse.

Despite these advances, corporate governance remains imperfect. But although there will always be cases in which mediocre executive performances are rewarded with high salaries, those who fail to deliver generally get the ax more quickly than in the past.

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In our 1995 book, The Winner-Take-All Society, Philip Cook and I argued that top salaries have been growing sharply in virtually every labor market because of two factors—technological forces that greatly amplify small increments in performance and increased competition for the services of top performers.        

Pay by relative performance is one defining condition of what we call a winner-take-all market. A second is that rewards tend to be concentrated in the hands of a few top performers, with small differences in talent or effort often giving rise to enormous differences in incomes. Both features show up in Sherwin Rosen’s description of the market for classical musicians:

The market for classical music has never been larger than it is now, yet the number of full-time soloists on any given instrument is on the order of only a few hundred (and much smaller for instruments other than voice, violin, and piano). Performers of the first rank comprise a limited handful out of these small totals and have very large incomes. There are also known to be substantial differences between [their incomes and the incomes of] those in the second rank, even though most consumers would have difficulty detecting more than minor differences in a “blind” hearing.

The enormous leverage of the most talented musicians was made possible by the development of breathtakingly lifelike recording and playback technologies. Now that most music we listen to is prerecorded, the world’s best soprano can be literally everywhere at once. And since it costs no more to stamp out compact discs from her master recording than from the master recording of any other singer, millions of us are each willing to pay a few cents extra to hear her rather than other singers who are only marginally less able. The upshot is that the best soprano lands a seven-figure recording contract while only marginally less gifted performers struggle to get by.

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The same logic holds in the market for leaders of large organizations. The trustees who recruited David J. Skorton as Cornell University’s 12th president in 2006 knew that his most important responsibility would be to head the university’s $4 billion capital campaign, which was then just getting under way. The hiring committee identified several candidates they felt would succeed in reaching that goal. They eventually decided, however, that none could have handled the task nearly as well as Skorton.

Having seen him in that role for the past several years, I find it easy to see why. Skorton, a man of great humor, warmth, and charm, is a distinguished research cardiologist and an accomplished jazz musician. Alumni adore him. If his compellingly articulated vision of the university’s future persuades them to donate only 3 percent more than the next-best candidate would have, he will have boosted the university’s endowment by more than $100 million.

I don’t know how much Dr. Skorton is paid. But many social critics expressed shock and outrage when it was reported that annual salaries of presidents of some private universities had passed the $1 million threshold several years ago. Leaders of David Skorton’s stature are in short supply, however—and because they’re so valuable, the real surprise is that they’re not paid even more.