Behind Rising Inequality: More Unequal Companies
More competition would help narrow the gap between the highest- and lowest-paid employees
In the past year, Apple said its shuttle-bus drivers would get a 25% pay raise. Alphabet (formerly Google) made its security guards regular employees with full benefits. Workers at Microsoft's largest contractors got paid leave. And Facebook raised wages for its cafeteria staff and janitors to $15 an hour.
These steps helped combat the widening gap between the economy's highest- and lowest-paid workers.
Yet in a little-appreciated way, these moves also illustrate why inequality has grown. Apple, Facebook and the others can pay their lowest employees more because these companies are, by a long shot, far more profitable than other companies.
Mounting evidence suggests the prime driver of wage inequality is the growing gap between the most- and least-profitable companies, not the gap between the highest- and lowest-paid workers within each company. That suggests policies that have focused on individuals, from minimum wages to education, may not be enough to close the pay gap; promoting competition between companies such as through antitrust oversight may also be important.
Peter Orszag, an executive at Citigroup and former budget director for President Barack Obama, and Jason Furman, chairman of Mr. Obama's Council of Economic Advisers,recently dug into the details of all the companies other than financial firms in S&P 500 stock index. What they found was a dramatic widening in their profit performance. A company at the 90th percentile—that is, more profitable than 90% of all other companies—saw its return on invested capital jump from 22% in 1982 to 99% in 2014. For the median company, the return climbed from 9% to just 16%, and for the company at the 25th percentile it stayed the same, at 6%.
Separate research suggests that pay has closely followed these companies' fortunes. Jae Song of the Social Security Administration and four co-authors looked at pay records of more than 100 million workers between 1980 and 2013, and compared their pay to that of other workers at the same firm. Workers at the 90th and 99th percentile did see their pay rise much more than median and lower-paid workers over the period. But no such disparity appeared among co-workers at the same firm: the ratio of their pay to their firm's average remained flat. In other words, everyone at the top companies, from the lowest to highest paid, pulled away from the pack, and everyone at the bottom companies languished.
Does this contradict the popular perception that inequality is driven by companies that pay their top executives ever fatter pay packets while their workers' income stagnates? Not entirely.
The economists did find that the top 0.2% of earners in firms with more than 10,000 employees did significantly better than their fellow workers. But for the other 99.8%, the expanding pay gap can be explained by where they work.
What accounts for this pattern? The economists speculate that workers are "sorting" themselves, with the most skilled all going to work for the same companies and the least skilled leaving those same companies. (Outsourcing may facilitate that.)
There is another, more troubling possibility. Some companies may so dominate their market that they can extract profits over and above what a purely competitive landscape would allow; economists call these excess profits "rents." Employees at those companies then share in those rents.
In the 1970s, both workers and shareholders of industries such as airlines and telecommunications shared in the rents made possible by the high regulatory barriers to entry. Deregulation sharply squeezed those rents.
Without such artificial barriers, abnormal profits at one firm should attract competitors, driving those profits down. Yet Messrs. Orszag and Furman found that between 1996 and 2014, profits at top companies became more skewed toward "super-normal" earners.
Their data show that the biggest gains in profits have been among technology and health-care companies such as drug manufacturers. Such companies' profits don't come from tangible assets, such as factories and land, but intangible assets, such as technology standards, patents and networks of customers or suppliers. This makes their products more useful, while at the same time presenting formidable barriers to would-be competitors.
Mr. Orszag acknowledges that high returns could reflect the windfalls that technology's big winners earn through the unique advantages of their business models, rather than anticompetitive behavior.
Still, their findings corroborate other evidence of corporate market power. Census data show that the share of markets considered "highly concentrated" under federal antitrust guidelines has grown since the 1990s. Low interest rates have spurred firms to buy one another and their own stock but capital investment has been historically weak, and business startups are depressed.
These trends underline the importance of competition policy, whether policing mergers and anticompetitive behavior more closely or ensuring incumbents don't use regulations to keep out upstarts—such as granting pharmaceutical companies excessive patent protection. More competition isn't just good for customers; it's good for workers, too.
Write to Greg Ip at greg.ip@wsj.com
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