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How much inequality growth is due to cross-firm productivity dispersion?
This paper surprised me, but I believe this (while not the last word) is a promising path to explore:
There has been a remarkable increase in wage inequality in the US, UK and many other countries over the past three decades. A significant part of this appears to be within observable groups (such as age-gender-skill cells). A generally untested implication of many theories rationalizing the growth of within-group inequality is that firm-level productivity dispersion should also have increased. The relevant data for the US is problematic, so we utilize a UK panel dataset covering the manufacturing and non-manufacturing sectors since the early 1980s. We find evidence that productivity inequality has increased. Existing studies have underestimated this increased dispersion because they use data from the manufacturing sector which has been in rapid decline. Most of the increase in individual wage inequality has occurred because of an increase in inequality between firms (and within industries). [emphasis added by TC] Increased productivity dispersion appears to be linked with new technologies as suggested by models such as Caselli (1999) and is not primarily due to an increase in transitory shocks, greater sorting or entry/exit dynamics.
Here is the link. Here are non-gated versions. Does this mean that firm-linked inequality will smooth out over time as the loser firms (or their replacements) mimic the technologies and methods of the winner firms? Of course some sectors may have permanently become more "winner take all."
The paper has two further results of note. First, much of the increase in wage inequality has come from changes in productivity dispersion in the service sector, not manufacturing. Second, Norway and France haven't had big boosts in wage inequality, and they also have not had comparable boosts in the inequality of productivity across firms.
Speaking of inequality, here is an interesting paper on the evolution of mobility and the American dream.
Posted by Tyler Cowen on August 30, 2007 at 06:57 AM in Economics | Permalink
Comments
With the caveat that I haven't read the paper: This can't be a long run equilibrium in the neoclassical sense then can it? If two firms in the same industry have different productivity growth rates then the price of the product would have to be higher, the rate of return lower, and/or the wages/prices paid to resources must be lower in the slow productivity growth firm relative to the high productivity growth firm. But this is not an equilibrium. In the long run, assuming open entry/exit in the relevant product and resource markets, these prices should all be the same across firms. The neo-classical prediction is that the low-productivity growth firms will go out of business as their workers look for other higher paying jobs, their wage costs rise, etc... In the end the wage inequality will self-correct as the firms go bankrupt.
Posted by: Bob Lawson at Aug 30, 2007 8:29:43 AM
A little off topic but:
A little off topic but:
I used to be a cook. Now that I work in a more profitable industry (I am a computer programmer) I ponder the great cooks that I worked with and the low pay level that they earned and even more so the high pay level of programmers. There are always plenty of kids coming out of school who could develop into good programmers so it is puzzling why the programmers pay is so high relative to cooks. Could it be because the profit levels are so low in the restaurant business? Could taxation be a factor in that cooking at home is tax free compared to eating out because the employees pay taxes - if we cook at home the transaction is untaxed this would end to suppress the demand for restaurant food and thus cooks wages. I understand that cooking is to some extent and art and so attracts some people willing to do it at lower wages but the difference seems bigger than can be explained by that alone. It seem to me in general that wages more competitive markets are lower. Am I correct on this?
Posted by: Floccina at Aug 30, 2007 9:33:13 AM
Floccina -- I suspect the causal relation works the other way. Because restaurants have a supply of cheap labor it is to their advantage to use labor intensive production process. The thing I have never understood is that the restaurant industry is increasingly dominated by large corporations yet it remains a low productivity, low wage industry. I suspect it is about the only industry where you would find Fortune 500 or S&P 500 firms employing large numbers of minimum wage employees. Is it because the restaurant industry is still an industry with very low barriers to entry so that mom & pop firms keep entering it using the same old technology? In other words restaurants continue to be a low wage, low productivity industry because it comes so close to meeting the requirements of the economist perfectly competitive model?
Posted by: spencer at Aug 30, 2007 9:47:33 AM
Floccina:
I believe your cross-industry comparison (i.e. restaurant and software) fails to take into account structural differences that are more decisive in terms of what may control the wage levels prevailing within a given industry. Also I note that the striking point in the article cited by Tyler deals with inequalities of firms within a given industry. That point is recognized by Spencer in his comment, but I believe he fails to give appropriate consideration of the structural aspects of the restaurant industry that may limit the ability to improve productivity in that industry.
The restaurant business is about providing a small number of perishable goods to the customer. Two factors noticeably limit the potential for improving productivity and increasing the general wage levels within the restaurant industry. These are: (1) the high cost of the raw materials (i.e. food stuffs) relative to the cost of the end product and (2) the short shelf life of the product. There is simply no opportunity to develop inventories and to thus leverage a productivity advantage. These factors reduce the opportunities for economies of scale and scope which are necessary for a more capital-intensive mass-production approach, even by large corporations. The low barriers to entry mentioned by Spencer also tend to discourage more capital-intensive approach.
Contrast the restaurant business with the automobile industry after Henry Ford's introduction of the assembly line. Ford's innovation had two effects. It radically reduced the cost of automobiles, significantly increasing demand, and, at the same time, enabling the increased demand to be met.
The software business presents a different paradigm from either the restaurant or automobile industry. The software industry essentially has only two types of costs each of which is extremely labor intensive. These are software development and marketing. The value added component of software is almost infinite relative to the cost of materials. The product itself has no physical manifestation and therefore does not need to be stored and has no shelf life. It is only threatened by technological obsolescence, which in turn, is a function of labor employed by competitors. It is not a mystery, consequently, that the wage level in the software business will on average exceed those in the restaurant industry.
Posted by: DWG at Aug 30, 2007 11:27:04 AM
You want to open a high-productivity restaurant? Easy: just bring the customers in, sit them down, and serve them TV dinners. The only problem is that nobody would eat there a second time. If people want high-productivity food products, they can buy them at a supermarket and eat them at home; restaurants serve as the alternative to that, so they're essentially defined as the low-productivity branch of the food business. Apparently food is one sort of good in which there's a sufficient difference between packaged products and hand-prepared ones that people are willing to pay the premium. The restaurateurs struggle against it, of course--many of them branch out into prepared foods, and some use prepared foods in their kitchens.
Posted by: y at Aug 30, 2007 12:16:05 PM
Floccina:
I've also been a cook (not a chef) and a programmer at different times in my 35 years as an adult. I'm sure you arfe c orrect that many intelligent kids who could become programmers. Some of those kids become computer programmers, accountants, engineers, physicians, nurses, lawyers, and numerous other occupations that require high intelligence. Of course not everyone possesses the intelligence to do those jobs. Computer programmers salaries are simply determined by supply and demand.
While I'm sure that significant intelligence is required to be a top chef, I don't think one must possess above-average intelligence to be a cook. The supply of potential cooks must be much larger than the supply of computer programmers. That's especially true because illegal immigrants can generally work as cooks but not as computer programmers.
Posted by: John Dewey at Aug 30, 2007 12:18:09 PM
v,
I agree that many consumers will reject prepared foods, and there are restaurants that cater to them.
On the other hand, McDonald's is still taking in billions of dollars. McDonald's employees do not hand-shape burger patties. They do not peel and cut potatoes. They do not mix ice cream, milk, and syrup into a milk shake. McDonald's has automated many of its processes and is still going strong.
As the meat buyer for a national chain years ago, I helped our kitchens alter food preparation processes. One example was the preparation of shredded beef. In early 1983 low-wage employees were roasting and then hand-shredding beef with forks. Six months later the beef was being cooked at the Montfort meatpacking plant in Greely, Co, and shredded by machines in large vats. The restaurant chain not only reduced labor costs, but also ensured a consistency of product across the entire chain. IMO, the latter factor was more important than the cost reduction.
Posted by: John Dewey at Aug 30, 2007 12:32:04 PM
Bob Lawson: "If two firms in the same industry have different productivity growth rates then the price of the product would have to be higher, the rate of return lower, and/or the wages/prices paid to resources must be lower in the slow productivity growth firm relative to the high productivity growth firm."
Two firms in the same industry do not necessarily serve the same customers. In the service industry, a firm can intentionally retard productivity growth in order to provide services that will differentiate it from the competition.
Consider the different strategies in the airline industry. Some firms pursue the price-sensitive customers by increasing worker productivity and resource utilization. Other firms have focused on providing cadillac-style, labor-intensive services. The two different strategies co-existed for a couple of decades. Only recently did the legacy carriers discover just how price-sensitive its U.S. customers have become.
American Airlines, for example, has reallocated much of its capacity to international flights. They realized that customers on longer flights are more willing to pay for the higher and more costly services they provide.
My short answer to your comment is that differences in productivity can exist for long periods when firms are successful in differentiating their product offerring.
Posted by: John Dewey at Aug 30, 2007 5:56:52 PM
"Does this mean that firm-linked inequality will smooth out over time as the loser firms (or their replacements) mimic the technologies and methods of the winner firms?"
Hrm. I'm not convinced. If we are to believe that we are in an era where technology changes rapidly and that pace of change is increasing, then I would believe that the amount of productivity difference and wage inequality will in fact increase over time.
Also, I think John Dewey has a point about differentiating yourself. Brand value is also value-added, after all. And differentiating yourself, while not a permanent advantage for any single company, can persist in the economy at large for a very long time as long as businesses have skilled marketers.
I would also like to note that globalization and technology probably increase the value of strategic partnerships, especially with foreign companies. If either foreign relations(IE, learning the language and the culture) skills or strategic and partnership management skills are lacking at present, it will be very difficult to build up these skills in a short period of time, also meaning it will take a while for this to "equalize."
This has been, in my opinion, one of the more enlightening papers I have read lately.
Posted by: Robert Olson at Aug 30, 2007 9:32:34 PM
One of the little secrets of high-cash businesses like restaurants is that mom&pops compete with the big boys by not reporting income, hiring workers under the table, and generally having lots of off-the-books, untaxed economic activity. Big chain restaurants can't easily do this - or at least they take far more risks if they attempt it.
And the food is often better at mom&pops, since standardized food delivery procedures produce standardized, uninteresting food.
Posted by: Foobarista at Aug 31, 2007 1:10:42 PM
Strikes me that there are considerable barriers to the free movement of technologies and skills that raise productivity.
For one thing, cartelizing regulations and other entry barriers protect the dominant players in an industry from too much "creative destruction" by new, innovative firms.
More importantly, though, when the innovative technologies are owned by the dominant firms, so-called "intellectual property" keeps them from being widely adopted.
So in effect the economic system is rigged with toll gates, erected on behalf of privileged corporations, to derive rents from their ownership of productive technology as long as possible.
But there's also another possibility: state capitalism increases the wage differential by subsidizing high-tech, capital intensive sectors at the direct expense of the rest of the economy. If this is so, then the average wage in smaller, more competitive, more labor-intensive industry is lower than it would be absent special privileges for the "commanding heights."
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