In chapter 8 I’ll argue that immigration may have promoted inequality in a more indirect way, by shifting the balance of political power up the economic scale. But the direct economic effect has been modest.
What about international trade? Much international trade probably has little or no effect on the distribution of income. For example, trade in automobiles and parts between the United States and Canada—two high-wage countries occupying different niches of the same industry, shipping each other goods produced with roughly the same mix of skilled and unskilled labor—isn’t likely to have much effect on wage inequality in either country. But U.S. trade with, say, Bangladesh is a different story. Bangladesh mainly exports clothing—the classic labor-intensive good, produced by workers who need little formal education and no more capital equipment than a sewing machine. In return Bangladesh buys sophisticated goods—airplanes, chemicals, computers.
There’s no question that U.S. trade with Bangladesh and other Third World countries, including China, widens inequality. Suppose that you buy a pair of pants made in Bangladesh that could have been made domestically. By buying the foreign pants you are in effect forcing the workers who would have been employed producing a made-in-America pair of pants to look for other jobs. Of course the converse is also true when the United States exports something: When Bangladesh buys a Boeing airplane, the American workers employed in producing that plane don’t have to look for other jobs. But the labor embodied in U.S. exports is very different from the labor employed in U.S. industries that compete with imports. We tend to export “skill-intensive” products like aircraft, supercomputers, and Hollywood movies; we tend to import “labor-intensive” goods like pants and toys. So U.S. trade with Third World countries reduces job opportunities for less-skilled American workers, while increasing demand for more-skilled workers. There’s no question that this widens the wage gap between the less-skilled and the more-skilled, contributing to increased inequality. And the rapid growth of trade with low-wage countries, especially Mexico and China, suggests that this effect has been increasing over the past fifteen years.
What’s really important to understand, however, is that skill-biased technological change, immigration, and growing international trade are, at best, explanations of a rising gap between less-educated and more-educated workers. And despite the claims of Lazear and many others, that’s only part of the tale of rising inequality. It’s true that the payoff to education has risen—but even the college educated have for the most part seen their wage gains lag behind rising productivity. For example, the median college-educated man has seen his real income rise only 17 percent since 1973.
That’s because the big gains in income have gone not to a broad group of well-paid workers but to a narrow group of extremely well-paid people. In general those who receive enormous incomes are also well educated, but their gains aren’t representative of the gains of educated workers as a whole. CEOs and schoolteachers both typically have master’s degrees, but schoolteachers have seen only modest gains since 1973, while CEOs have seen their income rise from about thirty times that of the average worker in 1970 to more than three hundred times as much today.
The observation that even highly educated Americans have, for the most part, seen their incomes fall behind the average, while a handful of people have done incredibly well, undercuts the case for skill-biased technological change as an explanation of inequality and supports the argument that it’s largely due to changes in institutions, such as the strength of labor unions, and norms, such as the once powerful but now weak belief that having the boss make vastly more than the workers is bad for morale.
The idea that changes in institutions and changes in norms, rather than anonymous skill-biased technical change, explain rising inequality has been gaining growing support among economists, for two main reasons. First, an institutions-and-norms explanation of rising inequality today links current events to the dramatic fall in inequality—the Great Compression—that took place in the 1930s and 1940s. Second, an institutions-and-norms story helps explain American exceptionalism: No other advanced country has seen the same kind of surge in inequality that has taken place here.
The Great Compression in itself—or more accurately, its persistence—makes a good case for the crucial role of social forces as opposed to the invisible hand in determining income distribution. As I discussed in chapter 3, the middle-class America baby boomers grew up in didn’t evolve gradually. It was constructed in a very short period by New Deal legislation, union activity, and wage controls during World War II. Yet the relatively flat income distribution imposed during the war lasted for decades after wartime control of the economy ended. This persistence makes a strong case that anonymous market forces are less decisive than Economics 101 teaches. As Piketty and Saez put it:
The compression of wages during the war can be explained by the wage controls of the war economy, but how can we explain the fact that high wage earners did not recover after the wage controls were removed? This evidence cannot be immediately reconciled with explanations of the reduction of inequality based solely on technical change…. We think that this pattern or evolution of inequality is additional indirect evidence that nonmarket mechanisms such as labor market institutions and social norms regarding inequality may play a role in setting compensation.[4]
The MIT economists Frank Levy and Peter Temin have led the way in explaining how those “labor market institutions and social norms” worked.[5] They point to a set of institutional arrangements they call the Treaty of Detroit—the name given by Fortune magazine to a landmark 1949 bargain struck between the United Auto Workers and General Motors. Under that agreement, UAW members were guaranteed wages that rose with productivity, as well as health and retirement benefits; what GM got in return was labor peace.
Levy and Temin appropriate the term to refer not only to the formal arrangement between the auto companies and their workers but also to the way that arrangement was emulated throughout the U.S. economy. Other unions based their bargaining demands on the standard set by the UAW, leading to the spread of wage-and-benefit packages that, while usually not as plush as what Walter Reuther managed to get, ensured that workers shared in the fruits of progress. And even nonunion workers were strongly affected, because the threat of union activity often led nonunionized employers to offer their workers more or less what their unionized counterparts were getting: The economy of the fifties and sixties was characterized by “pattern wages,” in which wage settlements of major unions and corporations established norms for the economy as a whole.
At the same time the existence of powerful unions acted as a restraint on the incomes of both management and stockholders. Top executives knew that if they paid themselves huge salaries, they would be inviting trouble with their workers; similarly corporations that made high profits while failing to raise wages were putting labor relations at risk.
The federal government was also an informal party to the Treaty of Detroit: It intervened, in various ways, to support workers’ bargaining positions and restrain perceived excess at the top. Workers’ productivity was substantially lower in the 1960s than it is today, but the minimum wage, adjusted for inflation, was considerably higher. Labor laws were interpreted and enforced in a way that favored unions. And there was often direct political pressure on large companies and top executives who were seen as stepping over the line. John F. Kennedy famously demanded that steel companies, which had just negotiated a modest wage settlement, rescind a price increase.