The Bad Bargain

Is the declining value of labor behind the dangerous rise in income inequality?

What explains the growing levels of income and wealth inequality inside rich countries? Data provide at least one answer: the share of income earned by investors has been steadily cutting into the share earned by workers. There are several factors behind this shift, but they all come down to one thing: bargaining power. That's where the problem is -- the question is whether it can also be the solution.  

Labor's share of national income has been falling slowly since the 1970s in rich countries around the world. A measure of labor's share called "real unit labor cost" -- in plain English, the total wages and benefits paid to all workers, divided by total output in an economy -- used to range from about 50 percent to 75 percent for countries in the Organization for Economic Cooperation and Development; now it's down to roughly 40 percent to 70 percent. What happened?

Economists like to tell three stories. The first is about union membership, which dropped steadily in the 1970s and 1980s before flattening out in the 1990s. Without unions, workers were in a weaker position to bargain with investors -- represented by corporate boards -- for their share of the profits from selling goods and services. Second is a story about the integration of the global economy. With new sources of labor coming online around the world, especially in Asia and Eastern Europe, workers' bargaining power in rich countries shrank still further. Finally, there were changes in technology. With more sophisticated machines and ways of doing business, it became easier to replace labor with capital. This was especially true in low-skill industries.

All three of these stories are really about bargaining power. As the influence of unions began to decline, workers had to compete against each other: myriad sellers of labor negotiating with just a few buyers. And with the onset of globalization, workers also had to compete with their counterparts overseas. Finally, with technological change, workers had to compete with machines. In each case, the bargaining power of individual workers slipped.

There's also a fourth story, and it has to do with the other side of the bargaining table. In the United States, the average size of firms rose from just over 15 employees in 1977 to about 23 at the end of the 1990s and stayed above 22 through 2009. In other words, the average number of potential employers for each worker sank, and fewer options for each worker meant even less bargaining power.

With these four forces in play, it's not hard to see why workers saw little increase in purchasing power despite their rising productivity. Yes, companies still wanted to hire them; unemployment rates in the 1990s and 2000s were some of the lowest on record in rich countries. But in retrospect, this was partly because labor was available on the cheap. Even with low unemployment, inequality grew.

Despite the ugly consequences for society of the decline in labor's bargaining power, some pundits have suggested that the trend is not a bad thing. For them, the solution is simply to turn workers into bigger investors.

In the United States, this notion is risible. Ranked by net worth, the lowest three quarters of families received less than 2 percent of their income directly from financial assets over the past decade, versus close to 80 percent from wages. Only half of families had indirect holdings of financial assets through pension funds, trusts, or other assets. To make any sort of dent in their dependence on labor income, you'd have to increase their holdings of capital by an order of magnitude at least. But as no one is just going to give financial assets to workers, you'd have to pay them with assets rather than regular salaries -- the same way many companies pay their top executives.

Yet then you'd be forcing millions of low-income people to rely on the volatile returns of stocks and bonds instead of the steady flow of wages. You could smooth out the returns through some sort of insurance scheme, but you'd essentially be punishing low-income people for being risk-averse -- a natural tendency when putting food on the table is the main concern.

Education may be a better answer. Bargaining power has eroded much less in high-skilled occupations that can't easily be sent offshore or replaced by machines, whether in factories or on farms. It's not easy for everyone to climb the skills ladder, though, and doing so takes time, especially with a U.S. educational system that's struggling to keep up with foreign competition.

A quicker fix might be for workers to take some of their bargaining power back. One way is for governments to negotiate for them, by raising minimum wages. Some states and municipalities have being doing this, but they risk companies relocating to lower-wage jurisdictions. Meanwhile, the percent of workers represented by unions actually dropped from 13.7 percent in 2008 to 12.5 percent in 2012.

Here in the United States, competition from abroad would remain even if Washington increased the minimum wage nationwide. The same would be true if American workers unionized en masse. The truth is that to stop the erosion of labor's bargaining power, action at home would not be enough; workers would have to act at the global level.

In other words, if you can't beat ‘em, join ‘em. To wrest income back from investors, workers would have to join together to limit companies' labor options all over the world. It may seem farfetched to imagine call center workers from Idaho negotiating alongside those from India, but it might also be the only way for the ones in Idaho to regain what they've lost. The question is whether the ones from India will go along.

Spencer Platt/Getty Images

Daniel Altman

Lemon Law

How crappy used cars explain the chaos in Thailand and Egypt.

Haven't we seen this movie before? Here's the plot: a democratically elected government tries to enact controversial new policies, protests ensue, the military gets involved, and soon the government is at risk of being forcibly removed. It's happened in Egypt, and now it may be happening in Thailand. But why?

A cynical observer might conclude that in both cases, the military was taking advantage of protests by a minority to hand power back to its favored elites. Yet there's a chance that the protests in Egypt and Thailand have actually represented the opinion of the majority. After all, plenty of Egyptians who voted for the Muslim Brotherhood were outraged by its attempts to consolidate power, just as many Thais who supported Prime Minister Yingluck Shinawatra were appalled by a proposed amnesty for corrupt politicians -- including her brother, the former Prime Minister Thaksin Shinawatra.

Perhaps voters just didn't get what they expected. But rather than wait for the next elections, they poured into the streets to demand immediate change. In Egypt, with the help of the military, they got it. Given the recent precedent, they may get it in Thailand as well.

This series of events bodes ill for democracy in both countries. Fortunately, at its root is a very familiar problem.

Imagine you're buying a used car. Some used cars are good and some are lemons, but you can't tell with certainty which are which. As a result, you'll never be willing to pay a seller the full value of a good used car; there will always be some chance that it's a lemon. And since no seller will be able to get full value for a good used car, only lemons will be for sale -- and no one will want to buy them.

This is Nobel laureate George Akerlof's market for lemons. Because of the asymmetry in information about cars between buyers and sellers, the market breaks down. The same can be true for politicians.

That's because elections suffer from an asymmetry of information, too. Voters can never be completely sure what politicians will do once in office, so there's always a chance that they'll disappoint voters in some way. This isn't a huge problem for democracy in itself; plenty of American voters were angered by George W. Bush's wars and Barack Obama's failure to chase down wrongdoers from the global financial crisis, but no coups or revolutions ensued. Yet when governments are more fragile, the electoral "market" can begin to break down.

In elections, politicians are the sellers of their own time and effort. They offer this effort in exchange for the power to implement their agendas. The trouble starts when that power can be easily taken away. Thai politicians have known since 1976 or earlier that they could be removed from office through means other than elections, and Egyptian politicians have learned it more recently. With only a tenuous grip on power, neither Egyptian nor Thai politicians will ever get "full value" for winning an election. As a result, Akerlof's model predicts that only lemons -- in this case, bad politicians -- will enter politics in Egypt and Thailand.

How can this problem be solved? One way is to protect elected governments. Rather than appearing to submit to the will of protestors, the military would back elected leaders to the hilt. But in countries lacking robust systems of checks and balances, an unconditional guarantee of security for elected governments might give them a license for all sorts of abuses.

Akerlof proposes some alternatives in his original paper. One is a warranty: if you're disappointed by the product you've purchased, you can get a new one or your money back. In politics, the closest thing to a warranty is the ability to impeach leaders or dissolve the government through a vote of no confidence (which, incidentally, Yingluck recently survived). Failing either of those mechanisms, frequent elections at least ensure that voters have a chance to pick new leaders on a regular basis.

Frequent elections have their drawbacks, though. Recently, the two-year cycle of national elections in the United States has come in for criticism, given the almost constant campaigning that has resulted. Some pundits have even suggested that the Chinese system, where politicians essentially have a ten-year mandate, is superior. Yet the Chinese and American models can both be viewed as fixes for the market for lemons.

In China, the government -- albeit not an elected one in a way Americans would recognize -- has a strong grip on power for a set period of time, offering "full value" to politicians. In the United States, mistaken "purchases" by voters can be quickly corrected. China puts the sellers first, while the United States favors the buyers.

Which group would you choose?