Larger Firms Create More Inequality

By Ramsey Barghout

Recently there has been a big debate about inequality in the rich world. Most economists have been putting forth the idea of increasingly unequal distribution of wealth, while paying less attention to the growing disparity in wages over the past years. Yet that disparity is growing. In America, for instance, “the best-paid 1% of workers earned 191% more in real (inflation-adjusted) terms in 2011 than they did in 1980, whereas the wages of the middle fifth fell by 5%. Similar trends can be observed all over the world, despite widely varying policies on tax, the minimum wage and corporate pay” (Shaffer 4).

One of the major reasons for this phenomenon lies behind the importance of technology. Modern economies require more skilled workers, which raises the pay premium they can demand. In addition, economists have recognized that economies of scale allow workers at bigger firms to be more productive than those at smaller ones. That, in turn, allows the bigger firms to pay higher wages. This should not, in theory, cause a rise in inequality. If, for example, the CEO and cleaner at a larger firm are both paid 10% more than their corresponding positions at a small firm, the ratio between their wages—and thus the overall level of inequality—should remain the same.

But studies show that the benefits of scale are not shared equally among all workers. Using data on wages at British firms, they divide workers into nine groups according to how skilled they are. Over time, they found that the proportional difference in wages between the groups grows as firms get bigger. This trend is driven entirely by a rising gap between wages at the top compared with the middle and bottom of the distribution. This is similar to the trend in income inequality in America and Britain as a whole since the 1990s, when pay for low and median earners began to stagnate.

Economists suggest two possible explanations. First, larger firms should find it easier to automate tasks than smaller ones, and may therefore find it easier to resist demands for pay rises from relatively unskilled workers who could be replaced by machines. In addition, entry-level workers in the middle of the income distribution may be willing to accept lower pay from big firms since in the long run the chances of getting a promotion are greater than at small firms.

Only the executive workers at a firm, who can extract a bigger premium for their skills and experience, enjoy the benefits of working at a large company. A cleaner at a single shop does the same sort of work as those at a large chain. But managing a multinational firm such as Walmart requires a different—and much rarer—set of skills than that required to run a corner store. Over time this pushes up the salaries of the top brass at Walmart compared with corner-shop managers.

Economists find that the relationship between the growth in the size of companies and the level of inequality holds across the rich world. They looked at data from over the years on wages and the size of largest firms for 15 countries in the OECD, a club mostly of rich countries. The relationship between rising levels of income inequality and the size of firms was strong.

This effect is particularly noticeable in America and Britain, where firms have grown rapidly in recent years. In America, for instance, the number of workers employed by the country’s 100 biggest firms rose by 53% between 1986 and 2010; in Britain the equivalent figure is 43.5%. On the other hand, in places where the size of firms has not changed much, such as Sweden, or where it has shrunk, such as Denmark, wage inequality has grown much less. Part of what is perceived as a global trend towards greater disparity in wages may actually be the result of the biggest firms employing a greater share of workers. (Swanson 2)

If governments want to resolve the inequality big firms are causing, reforms to the labor market are unlikely to help. Instead, they will have to create competition by reducing barriers to entry for smaller firms, most probably by improving their access to credit. This should reduce income inequality and boost economic growth at the same time. Most people dislike the growing inequality of incomes, and often argue for redistributive policies to resolve it. Yet too much unskilled redistribution can be counterproductive in that it tends to dampen economic growth. The link between firm size and inequality suggests a better option. By boosting competition, policymakers can please both the public and economists at the same time.

Sources

Morduch, Jonathon. “Failure vs Displacement.” Elsevier. New York University, 24 July 2013. Web. 11 Apr. 2015.

Shaffer, Ronn. “Rethinking Community Economic Development.” Sage Journals. University of Wisconsin, n.d. Web. 11 Apr. 2015.

Stohr, W. B. (1989). Local development strategies to meet local crisis. Entrepreneurship & Regional Development, 1(3), 293-300.

Swanson, L. (1996). Social infrastructure and rural economic development. In T. D. Rowley, D. W. Sears, G. L. Nelson, J. N. Reid, & M. J. Yetley (Eds.), Rural development research: A foundation for policy (pp. 103-122). Westport, CT: Greenwood.

Taylor-Ide, D., & Taylor, C. E. (2002). Just and lasting change: When communities own their futures. Baltimore: John Hopkins University Press.

Advertisements

About economicsandtheworld

To Broaden The Understanding Of Economics Around The World.

One response to “Larger Firms Create More Inequality

  1. Dear Ramsey,

    Thank you for such a thoughtful article on a theme which affects us all in some way. Inequality is a complex issue, it is not as black and white as it may appear. You have reminded readers of the intricacies involved in looking at inequality and that there is much more to it beyond the surface.

    ~Professor Myra Chaudhary

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Authors

%d bloggers like this: