UNCOMMON SENSE 13 © February 1998

by David R. Howell, Assoc. Prof. and Chair, Urban Policy Program, Robert J. Milano Graduate School, The New School for Social Research

Wage Decline and Inequality Increase

No recent development in the US labor market has been more dramatic and troubling than the collapse in the buying power of workers’ paychecks. In 1973, after rising for almost three decades, average real (inflation-adjusted) earnings of US workers began to decline. Average hourly earnings of production and nonsupervisory workers fell by 15 percent, from $13.89 in 1973 to $11.82 in 1996 (both in 1996$).1 In other words, average workers earn less now than their counterparts did several decades ago. Though wages now are rising very slowly, they have yet to return to 1980s levels, much less those of the 1970s.

To understand what caused this drop, it is important to recognize that the steepest fall in earnings took place in the 1980s. At the same time as real wages plummeted, earnings inequality rose spectacularly. Especially notable is the widening wage gap between highly and poorly educated male workers. Two wage trends in the 1980’s stand out: the real earnings of college-educated women grew rapidly (up 14 percent), and the earnings of poorly educated men declined substantially (down 11 percent for those with just a high school diploma and 20 percent for those without). The real earnings of less-educated men also fell in the 1970s, but not as much as in the 1980’s. In that decade, the percentage declines were three to four times larger; equally significant, average earnings of college-educated men rose only modestly.

What do these data mean? They mean that the growth of earnings inequality among men was due mainly to the sharp drop in the earnings of less-educated workers rather than to increases for college-educated ones.

More important, during the 1980s, the proportion of less-educated workers able to rely on wages to keep their families out of poverty tumbled. Between 1979 and 1989, the fraction of employed male high school graduates who earned less than the poverty line for a family of four rose from 8 to 15 percent. For men with only some high school, these rates rose from 13 to 30 percent. Minorities fared even worse: among the employed, 25 percent of black men and 41 percent of Hispanic men without a high school diploma earned incomes below the poverty line in 1989–far more than in 1979.2

In the 1980’s, the number of college graduates increased rapidly, and their growth outstripped the creation of jobs requiring a college education. That’s a reasonable explanation of why wages of college graduates increased so modestly in the 1980s. But what about the collapse of earnings at the bottom of the ladder? That is almost universally attributed simply to a decline in demand for low-skilled workers. The claim is that there is a growing mismatch between the skills required by firms and the skills of the workforce.

Skills mismatch: technology and trade

Most economists blame the presumed mismatch of skills on technological change in the workplace.3 Some also argue–though it is controversial–that there is a surplus of low-skilled workers because competition from low-wage countries has eliminated many unskilled domestic jobs. To some extent, these explanations are popular because they seem to be consistent with reality. We can see that computers, which are assumed to require upgraded skills (though they sometimes downgrade skills) are now used in most workplaces. And every shopper knows about the huge influx of imports of consumer goods.

There is another reason why technology and trade are such appealing explanations: they fit in nicely with the simple, conventional view of the labor market.4 According to this textbook analysis, market forces–the supply and demand for labor–determine wages. Suppose, for example, there is no change in the supply of less-skilled workers and the demand for them has been driven down by new technology, which has created jobs for which they cannot qualify. Suppose, too, that cheap imports have destroyed many of their usual jobs. Using this traditional interpretation, both wages and employment of low-skilled workers would be expected to fall. Their wages would also be expected to decline relative to those of skilled workers, who can take the jobs created by the new technology. What is the main implication of this analysis? It is that training and upgrading of skills are the only way to raise the earnings of low-skilled workers, who otherwise are doomed to low wages. From this perspective, nothing else needs fixing–like government policies that favor employers, curbs on anti-union practices, raising minimum wages, and so on.

On the surface, the skill-mismatch explanation seems plausible. There is, however, little evidence to support it. The mismatch assumption leads us to expect a sharp reduction in the number of low-skill (and low-wage) jobs, especially as the supply of low-skill workers has also declined. That is, the share of the labor force with less than a high-school education has diminished. Similarly, the greater demand for high-skill workers should lead to an increase in high-skill (high-wage) jobs. If both shifts occur simultaneously, as the skill-shift theorists contend, we should observe rising joblessness and declining shares of the low-skill workers in the labor force. But what we actually observe is quite different. After 1982, the skill distribution is quite stable. In fact, the low-wage share of employment increased sharply between 1979 and 1989.

What actually happened to low-skilled workers?

The simple textbook model of the labor market, which lies behind the skill mismatch explanation, is not the whole story. Wages are set not only by market forces. Labor’s bargaining power is important. Wage-setting institutions (like unions and minimum wages) do matter. So there is an alternative explanation for the collapse in wages for the low-skilled–one that puts at center stage the new confrontational approach adopted by many employers in the 1980’s and a simultaneous shift by government toward laissez-faire public policies.

The political environment is one in which government policies have become far more favorable to employers and hostile to workers. Also, spurred by the success of confrontational labor practices by some highly visible large firms in trade-sensitive industries, employers abandoned long-accepted practices designed to shield workers from the full force of labor market competition. “Effective” management became synonymous with “low-road” wage and employment policies aimed at reducing short-run labor costs. These included challenging the legitimacy of labor unions and collective bargaining, demanding wage and benefit concessions, firing strikers and hiring permanent replacements, relocating plants to low wage sites, outsourcing to low-wage firms, and relying more on low-wage part-time and temporary workers.

These employment practices were encouraged by Wall Street, which has put increasing pressure on management to maximize short-run profits. Government policy greatly facilitated the low-road strategy by placing the priority on fighting inflation by creating unemployment; deregulating key industries; allowing unemployment insurance levels and coverage to erode; weakening the enforcement of labor laws and anti-trust enforcement; and by allowing the value of the minimum wage to decline sharply, thereby undermining the wage floor that had propped up the entire lower end of the wage structure. The federal government itself gave the signal that it was respectable to fire striking workers and hire permanent replacements when President Reagan fired striking members of the air traffic controllers’ union in 1981. And the Reagan recession was the worst since the Great Depression. It sent annual unemployment soaring to nearly 10 percent in 1982 and 1983 and 7 percent or above through 1986. What could be a more congenial environment for weakening unions and forcing workers to accept wage cuts or contingent work?

Recent empirical studies strongly support this alternative explanation of the wage collapse. So does the anecdotal evidence on wage concessions, outsourcing, plant relocation, and the use of contingent and part-time workers. To understand the wage collapse and counter it, these direct causes must be seen in the larger context of a new, more competitive business environment. Political and ideological shifts have lifted the constraints on “low-road” management strategies whose aim is to reduce costs by beating down labor rather than by creating high-performance workplaces.

These policy shifts reflected more than just changing business conditions. Other rich nations faced similar economic challenges without dismantling institutions designed to protect the living standards of low-skill workers. The distinguishing feature of the US wage collapse is in the political, ideological, and institutional realms. Other nations have chosen to operate under different labor market rules. As noted labor economist Richard Freeman points out, “the United States represents the decentralized extreme in wage setting,”5 and decentralized bargaining is generally associated with larger wage differences among workers. Still, since the late 1970s, political and management choices have been made to move further in this decentralized direction. Wage-setting institutions that had once provided some protection from the forces of labor market competition have been undermined or dismantled. It was no coincidence that among developed countries, only Great Britain, also relatively decentralized, experienced a comparable increase in inequality. But the UK experience was different in one crucial respect: real earnings among the least skilled increased. The collapse of wages for those with low educational attainment was a uniquely American phenomenon.

Few would, or should, oppose public sector efforts to raise the skill level of the workforce, but worker skills have had little to do with the startling growth in poverty-wage jobs, the drop in real earnings, and the growth of inequality in the 1980s. We need to improve our education and training system, but this will not, by itself, have much effect on the distribution of earnings, and certainly not soon. Besides, most jobs will continue to require less than a college degree, and a labor market that increasingly offers poverty-wage jobs to these workers provides them with little means to invest in education and training.

What can we do?

An effective public policy response must address the roots of the earnings problem: we have relied too much on market forces to set wages and employment conditions. We need to reestablish and improve the wage-setting institutions that sheltered low-skill workers from the worst excesses of labor-market competition and encouraged management-labor cooperation. While the details of such a program require careful debate, the direction to take is clear. A good place to start would be strengthening the ability of workers to bargain collectively and reversing the steep decline in the value of the minimum wage since the 1960’s. Though collective bargaining agreements set wage and employment conditions for 18 percent of American workers, they cover more than 80 percent of workers in Sweden, Germany, Belgium, France, and Austria.6 The recent increase in the minimum wage will restore it to only 74 percent of its value in 1968. The minimum wage in France is set at 60 percent of the average wage. This would imply a minimum wage for the United States of over $7 an hour, roughly its peak value in real terms, achieved in 1968.

We also need policies that will put us on the road to full employment. Unions, which have begun an organizing campaign to reverse their membership erosion, can make greater gains when labor markets are tight. Sustained tight labor markets will also help push up wages. Recent welfare “reform” works in the other direction, by increasing the supply of low-skilled workers without increasing the supply of jobs, and by workfare programs which threaten the jobs and wages of regular workers, especially those in jobs requiring only modest education.7

Faced with an increasingly competitive world, US policy makers and employers made choices that reshaped the way our labor market works. Low-skill workers have paid the price for those choices in the form of sharply declining living standards while high-income consumers, some highly skilled workers, and stockholders have benefited. This massive redistribution of economic well-being cannot be maintained for long: it undermines living standards and morale and, hence, the productivity of the workforce. It also undermines our ability to prepare the next generation for productive work and citizenship. The low-road of wage cuts and employment insecurity will not create a high-performance economy and it is not the path being taken by most of our industrialized competitors. It is time to reclaim control over the way our labor markets function. Real full employment is needed and that means decent wages as well as jobs for all.
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*This article is adapted from Levy Economics Institute Policy Brief No. 29, 1997.

Notes:

1. Average hourly earnings for nonsupervisory workers (Economic Report of the President 1997, Table B-45) were
deflated by the CPI-U index adjusted to 1982=100 (Table B-58). Average weekly earnings declined more steeply: by 7.5
percent between 1973 and 1979, 11.0 percent between 1979 and 1990, and another 1.4 percent from 1990 to 1996 (Table
B-45.

2. Gregory Acs and Sheldon Danziger, “Educational Attainment, Industrial Structure, and Male Earnings Through the
1980s,” The Journal of Human Resources 28: 3 (1993), 618-648.

3. John Bound and George Johnson., “Changes in the Structure of Wages in the 1980s: An Evaluation of Alternative
Explanations,” American Economic Review 82: 3 (June 1992), 371-392.

4. Steve J. Davis and John Haltiwanger, “Wage Dispersion Between and Within US Manufacturing Plants, 1963-86,”
Brookings Papers on Economic Activity: Macroeconomics 1 (1991): 115-200.

5. “How Labor Fares in Advanced Economies,” in Freeman, ed., Working Under Different Rules, New York: Russell
Sage Foundation, 1994.

6. Freeman, “Labor Market Institutions and Earnings Inequality,” Boston Federal Reserve Bank, Nov. 17, 1995.

7. See the Coalition’s welfare packet.

References:

Card, David, Francis Kramarz and Thomas Lemieux. 1995. “Changes in the Relative Structure of Wages and Employment: A Comparison of the United States, Canada and France,” Working Paper #355, Industrial Relations Section, Princeton University

Karoly, Lynn A. 1994. “The Trend in Inequality Among Families, Individuals, and Workers in the United States: A Twenty-Five Year Perspective.” In Danziger and Gottschalk, eds., Uneven Tides: Rising Inequality in America (New York: Russell Sage): 19-97.

Editors: June Zaccone, Economics (Emer.), Hofstra University and Helen Lachs Ginsburg,, Economics (Emer.), Brooklyn College, CUNY