Academic journal article Economic Inquiry

Income Inequality: The Consequences of Skill-Upgrading When Firms Have Hierarchical Organizational Structures

Academic journal article Economic Inquiry

Income Inequality: The Consequences of Skill-Upgrading When Firms Have Hierarchical Organizational Structures

Article excerpt

I. INTRODUCTION

Over the last three decades, most developed countries have experienced increasing income inequality (OECD 2007). A recent OECD report (OECD 2011) pointed out that traditionally low-inequality countries such as Denmark, Germany, and Sweden also experienced significant increases in income inequality during the 2000s. In Denmark the average annual percentage change in income was 1% over the period mid-1980s to late 2000s. But income progression was very unequal across income deciles. While the bottom decile experienced annual income growth of only 0.7%, the top decile had earnings growth of 1.5%. Other sources also point toward increasing income inequality in Denmark. For example, Atkinson and Sogaard (2013) study income inequality in Denmark over the past century and find that income inequality at present is at a relatively low level--but that it has been on the rise since the early 1990s.

In this article, we intend to shed light on the causes of the increasing income inequality observed in Denmark during the period 1992-2007. We do so using register-based employer-employee data. We find that income inequality has indeed increased in Denmark during this period. We also show that this increase occurred during a period where the inflow of highly educated workers into the labor market was substantial and management compensation grew steadily. To better understand this interplay between skill-upgrading, management compensation, and income inequality, we propose an equilibrium search model where the firm has an explicit organizational structure. An important feature of this model is that the endogenously determined management and education premia (two important drivers for income inequality) can be established and studied. Furthermore, this model is capable of reproducing the dynamics in income inequality observed in Denmark over the sample period when it is subjected to skill-upgrading.

Our focus on skill-upgrading and management compensation as drivers for income inequality implies that our paper is in line with a large U.S. literature on income inequality (e.g., Juhn, Murphy, and Pierce 1993; Katz and Autor 1999; Katz and Murphy 1992). (1) This literature documents a substantial widening of U.S. income distribution during the 1980s and establishes that the action in the income distribution is at the top income percentiles (where most managers are located). The literature also documents that the supply of highly educated labor grew steadily in the United States during the 1980s. More recent papers by Autor et al. (2008) and Autor, Levy, and Mumane (2003) have revisited the question of growing income inequality in the United States using data for the 1990s. They find that the increase in income inequality has continued, but at a slower pace. On reason is that real wage growth was U-shaped in the United States in the 1990s. (2)

Our analysis also complements the existing Danish literature on income inequality. A recent contribution by Neamtu and Westergard-Nielsen (2013) investigates changes in Danish income inequality with a focus on the effects of changing demographics, family formation, and aging. Bjornskov et al. (2012) take a related approach but include a discussion of social impacts and political economy. Finally, Atkinson and Sogaard (2013) take the long-term perspective and establish how income inequality has changed during the last 140 years. Our article adds to this literature by investigating the interplay between skill-upgrading, management compensation, and income inequality.

We start our analysis by investigating change in Danish income inequality using register-based employer-employee data for all private sector workers between 1992 and 2007. We establish three empirical results. First, in line with previous evidence, we document that Danish income inequality has been rising. Second, the employment share of highly educated individuals has increased substantially both in management and nonmanagement. …

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