This article from The Economist newspaper (yes, they insist it is a newspaper and not a magazine) discusses recent research that finds the causes of a macroeconomic problem (inequality) in a microeconomic variable (size of the firm). The research focuses on growth disparity in wages, instead of focusing on wealth disparity (as Piketty does) to explain rising income inequality across the world. Growth in wage disparity is increasing despite varying policies on taxation, minimum wages and corporate pay.
A new paper by Holger Mueller, Elena Simintzi and Paige Ouimet, called "Wage Inequality and Firm Growth", links the increasing inequality of wages on the size of the firm, i.e. the bigger the firm, the more unequal the wage pay. It is common knowledge among many economists 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".
Theoretically, this should not increase wage inequality, if all workers at the firm receive a proportional pay increase. However, this paper shows that most such firms distribute progressive pay increases. This trend is very similar to "the trend in income inequality in America and Britain... since the 1990s, when pay for low and median earners began to stagnate", the writers of the research paper note.
They suggest two possible reasons for proportional pay increase:
1) The low-skilled workers who demand higher wages can be easily automated away
2) Entry-level workers may accept low wages as the chance of promotion at a larger firm is higher than that at a smaller firm.
They also note that the job requirements in smaller versus larger firms explain why the most senior people reap such high wage increases. A janitor's job requirements are the same in small- and large-scale companies, but a manager's skill set for large companies is not only more demanding, but also rarer.
The article then discusses potential causation between the rise in income inequality and the rise in wage inequality. The research paper shows that the size of the largest 15 firms in OECD countries and their income inequality, stating that this relationship is strong.
Another recently published paper, "Entry Costs Rise with Development" by Albert Bollard, Peter Klenow and Huiyu Li shows that "the trend towards bigger firms is only likely to accelerate". The higher productivity in big firms leads to increased barriers of entry for smaller ones, as shown by the fact that, in America and Europe, startup rates for companies are falling. Since the 2008 crisis, higher barriers in the form of limited access to capital "has caused the number of new businesses to collapse," the article says.
Some economists point out the positives of this: bigger firms have much higher investment rates, which increases growth in the economy. In fact, it is the preponderance of small firms that is holding the PIGS economies back from economic recovery.
If governments wish to reduce this inequality, they should reduce barriers to entry to spur competition, by improving small businesses' access to credit. But, they should also be wary of too much crude redistribution, as it dampens economics growth.
1. Economies of scale: This is when a firm reaps the cost benefits due to their large size or output. According to Wikipedia, it is when “cost per unit of output generally [decreases] with increasing scale as fixed costs are spread over more units”.
2. Corporate pay comprises of various forms in which companies pay its workers, including for example, share options.
1. The first new paper by Mueller, Simintzi and Ouimet is here. The second new paper by Bollard, Klenow and Huiyu is here.
2. What does the phrase “limited access to capital” mean? In a nutshell, it means loans or equity to finance the business venture.
3. In the last paragraph, the author mentions “too much crude redistribution”. This will be explained in the S&P article on the link between inequality and growth in America that I will be publishing soon.
4. The author seems to assume causation between the size of the firm and the level of inequality in a country. The author mentioned research where the first paper by Mueller, Simitzi and Ouiment find that “the relationship between rising levels of income inequality and the size of the firms was strong”. This statement suggests correlation. Later on, the author states that a few solutions to the rising inequality is to lower barriers of entry, thereby increasing competition and allowing smaller firms to participate in the market. This suggests causation. While there may be evidence to show direct causation between inequality and firm size, it has not been mentioned in this article.
5. On the note of disproportionate wages, perhaps more skilled workers get higher pay because they are the ones who can create the benefits of scale, i.e. they are the ones who can make the products to be shared worldwide. This point should not be taken to mean that I am suggesting that more skilled workers deserve the disproportionate wage rises; that is outside the domain of economics. But the question is whether they disproportionately "create"the higher returns to scale; that is a question well within the realm of economics, but the authors of paper have not addressed it directly.
6. The data in this article was taken from Britain. If they had used the same methodology in the US, would they have come up with different results? Arguably, much wealth in the US has been created by small start-up firms and hence is it possible that one might not find similar disproportionate pay rises in larger firms?
Click here to read the original article.