1

The Evolution of the Distribution of Individual Earnings in OECD Countries

A B Atkinson, Nuffield College, Oxford and Paris School of Economics

Sydney February 2007

2

Introduction

1. Taking the Supply and Demand Story Seriously

• Modelling the race between technology and education

• Quantities and Prices

2. Empirical Evidence about Earnings Dispersion

• An augmented dataset on earnings for 18 OECD countries

• Patterns of change

3. Enriching the Story

• A Behavioural Model of Changing Pay Norms

• Earnings at the top: superstars and managerial pyramids

Conclusions

3

Increasing decile ratio in the US 1980-

2.8

3.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

De

cil

e r

ati

o P

90

/P1

0

4

or ?

Were the 1990s a Pause or have we reached a Plateau?

5

Textbook Story

There is general agreement that the main factor behind

the increase in the relative wage of skilled versus

unskilled workers is a steady increase in the relative

demand for skilled workers. (Blanchard,

Macroeconomics, page 524).

Globalisation: fall in relative price of goods in which unskilled workers are more intensively engaged.

Technical progress biased in favour of skilled workers.

6

Relative demand for qualified workers Ls/Lu

Relative wage of qualified workers

ws / wu

denoted by ω

Shift in Demand

●

●

7

Missing

• Dynamic story but dynamics not modelled.

• Distribution of earnings depends on quantities as well as prices; cannot just look at wage differential.

• “New” theories of labour market – Section 3.

• Inter-relation between labour and capital markets.

K Arrow and W M Capron, “Dynamic Shortages”, QJE 1958

8

At any point in time, supply of qualified workers is fixed at S and relative wage ω clears the market

D[ω] = S

Over time, demand shifts at exogenous rate g

dlnD/dt = g – σ dlnω/dt (1)

Supply adjusts according to premium over cost of acquiring education, which is assumed to be simply that of postponing entry to paid work by T years, r is the cost of borrowing

dlnS/dt = β [ ω - e rT ] (2)

Hencedlnω/dt = (β/σ) [g/β + e rT - ω]

Simple temporary equilibrium model

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dlnω/dt = (β/σ) [g/β + e rT - ω]

β zero means pure rent, differential grows without limit

β positive means convergence

β infinite means pure compensating differential e rT

Relative earnings

g/β + e rT

erT

10

Relative demand for qualified workers Ls/Lu

Relative wage of qualified workers

ws / wu

● ●

erT

+ g/β

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• Casts doubt on criticism of the Skill Biased Technical Change (SBTC) hypothesis: “our main conclusion is that aggregate wage inequality has not risen continuously since the 1970s. … This suggests a potential problem for the SBTC hypothesis: why did the pace of SBTC slow down after an initial burst during the first few years of the microcomputer revolution?” (Card and DiNardo, JLE, 2002).

• But Also: Wage premium depends on β, which may vary from country to country.

• Wage differential may have increased because of rise in the cost of borrowing

= inter-connection between labour and capital markets.

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HOWEVER Distribution depends on Changes in Quantities as well as on

Wage Differential• Kuznets model = model of quantity changes.• Societies becoming more educated = same kind of

structural change.• (With constant wage premium) tends to shift Lorenz

curve outwards at bottom and inwards at top.• ? Increase in dispersion among qualified workers ?

13

Lorenz Curve

P10 P 90

Share of total population

Share of total earnings

SKILLED UNSKILLED

Effect of rise in ratio of skilled to unskilled in labour force

Increase in dispersion among the skilled

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2. Empirical Evidence about Earnings Dispersion

OECD View“ Gross earnings inequality has increased on average

in OECD countries for which data are available. This occurred in countries where labour market performance improved considerably (Australia, the Netherlands), as well as in countries where it deteriorated (Germany, Hungary, Korea and Poland). Broadly unchanged wage dispersion was recorded in [France, Japan, Switzerland and UK]”.

Assessing the Jobs Strategy May 2005

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USA

UK

CHE

SWE

POL

NLD

KOR

J PN

HUN

DEU

FRA

FIN

AUS

2

3

4

5

2 3 4 51994 ratio

2000 ratio

OECD comparison of 2000 and 1994

Decile ratio

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• Short time period

• Series are not necessarily consistent over time

• Looks at decile ratio, not bottom and top deciles separately

• No clear metric: what constitutes a “rise”?

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An Augmented Database

• 18 OECD countries

• Identifies breaks in series

• Multiple sources for most countries

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Gottschalk and Smeeding (1997)

AUS, CA, FI, D, ISR, NL, SWE, UK, US

“Almost all industrial economies experienced some increase in wage inequality among prime-age males during the 1980s (Germany and Italy are the exceptions). … But large differences in trends also exist across countries, with earnings inequality increasing most in the United States and the United Kingdom and least in the Nordic countries”

Katz and Autor (1999)

AUS, OS, CA, FI, FR, D, IT, JA, NL, NZ, NOR, SWE, UK, US

“The United States and the United Kingdom experienced sharp increases in overall wage inequality … The pattern of declining wage inequality apparent throughout the OECD (except the United States) in the 1970s ceased in the 1980s and 1990s in almost all nations (with Germany and Norway as possible exceptions). Canada, Australia, Japan, and Sweden had modest increases in wage inequality … Wage inequality narrowed through the mid-1980s in Italy and France with some hint of expanding in France in the late 1980s and with a large increase in inequality in Italy in the 1990s … New Zealand also shows large increases in inequality”

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Metric• 1979/1980/1981

• versus

• 1999/2000/2001

Five percent criterion for change to “count”

P10 50 P90 180 DR 3.60

P10 47.5 P90 189 DR 3.98

Significant = increase of Ten percent or more

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Change in Bottom Decile % 1980-2000

-15

-10

-5

0

5

10

15

Austra

lia

Austri

a

Canad

a

Czech

R

Denm

ark

Finla

nd

France

Germ

any

Hungar

yIta

ly NL

Norway NZ

Polan

d

Portu

gal

Sweden UK US

21

Rise in Top Decile % 1980-2000

0

5

10

15

20

25

Austra

lia

Austri

a

Canad

a

Czech

R

Denm

ark

Finlan

d

Franc

e

Germ

any

Hungar

yIta

ly NL

Norway NZ

Polan

d

Portu

gal

Sweden UK US

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0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

STABILITY

FallSome recovery

Fanning Out

Top decile

Bottom decile

P80

P70

P60

P40P20 and P30

Earnings deciles in the UK (1977 = 100)

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All workers ■ FT adults ٭ FT non-managerial ○

WEE (for comparison) ∆

Australia Results from Employee Earnings and Hours Survey

0

20

40

60

80

100

120

140

160

180

200

1974 1979 1984 1989 1994 1999 2004

Top decile

Bottom decile

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Share of top 1% in total EARNINGS

3

4

5

6

7

8

9

10

11

1946 1950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998

% s

ha

re t

ota

l e

arn

ing

s

Share of Top 1%

FRANCE

US

CA

UK

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Summary of empirical evidence

• Important to look separately at bottom and top deciles

• 7 out of 18 saw fall in bottom decile of 5% or more from 1980 to 2000

• Majority ( 14 out of 18) saw rise in top decile; in 7 out of 18 rise exceeded 10%

• In UK and US, decile ratio broadly stable since 1990 because rise in bottom decile offsets rise in top decile

• Behaviour at top differs across countries.• Need to explain distribution among the qualified.

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Enriching the Story

Two of many possibilities:

• Behavioural pay model, with shift in pay norms (Atkinson, 1999)

• Superstar rents and managerial pyramids at top

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Employer

Worker

Conform Not conform

Conform Match

Pay follows code

No match

Not conform No match Match

Paid according to individual productivity

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Jobs adhering to pay norm

Belief about degree of acceptance of pay norm

0

100%

100%

E2

E3

E1

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Jobs adhering to pay norm

Belief about degree of acceptance of pay norm

0

100%

100%

E2

E3

E1

E1*

Firms with higher discount rates attach less weight to reputation

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Superstar Theory(Alfred Marshall 1890s and Sherwin Rosen 1980s)

+ Gives role to both technology and trade

- No direct link to distribution

? Explain earlier periods when top earnings fell?

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Log (Earnings/median)

Log [1/(1 – F)]

Effect of trade and technology in expanding share of rents captured by top performers = fall in α

Superstar model generates extreme value distribution with Pareto tail with exponent α

Slope = 1/α

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Managerial Hierarchy Model (Lydall and Simon)

β =

loge[span of managerial control]

divided by

loge[1+ increment with promotion ]

span

increment 25%

5

7.2

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Log (Earnings/median)

Log [1/(1 – F)]

Superstar model not enough on its own, since not explain earlier rise in α

Hierarchical Salary Model

Hierarchical model not enough on its own, since predicted Pareto exponent β too large

-

+

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Not just a simple Race between Technology and Education• we have to study dynamics; there may be a temporary equilibrium with constant premium for qualified workers; there may be cobweb cycles.

• Distribution depends on quantities as well as wages.

• There has been widening of earnings dispersion in majority of OECD countries, but rises in decile ratio due more to changes at top than at bottom.

• Need to take account of “new” theories of the labour market, such as behavioural models of pay norms.

• Top earnings could be explained by mixture of hierarchy and superstar theories.