How Between-Firm Inequality Drives Economic and Social Inequality

"The real engine fueling rising income inequality is `firm inequality': In an increasingly winner-take-all or at least winner-take-most economy, the best-educated and most-skilled employees cluster inside the most successful companies, their incomes rising dramatically compared with those of outsiders. This corporate segregation is accelerated by the relentless outsourcing and automation of noncore activities and by growing investment in technology."

So argues Nicholas Bloom in his essay, "Corporations in the Age of Inequality," which appears as a cover story in the March 2017 issue of the Harvard Business Review.  The basic idea won't be new to long-time readers of this blog. For example, I discussed some earlier work by Bloom together with co-authors Jae Song, David J. Price, Fatih Guvenen in "Earnings Inequality Between Companies" (July 6, 2015) and a study by the OECD on this subject in "Productivity Growth and the Diffusion Problem" (July 14, 2015).  But this essay is a very nice compact and readable overview of the work. 

As a starting, instead of looking at the distribution of income between people, look at the distribution of average salaries across companies. As this figure shows, average salaries for companies in the 99th percentile of companies has grown substantially, while average salaries at the 25th and 50th percentile of companies hasn't grown much.

This pattern is also apparent within industries: that is, if you just look at manufacturing firms, or just look at services firms, the labor productivity of the top firms is pulling away from the labor productivity of other firms. Here's a figure from Bloom's essay, drawing on the OECD study mentioned earlier.



Bloom summarizes what is happening this way:

"In other words, the increasing inequality we’ve seen for individuals is mirrored by increasing inequality between firms. But the wage gap is not increasing as much inside firms, our research shows. This may tend to make inequality less visible, because people do not see it rising in their own workplace. This means that the rising gap in pay between firms accounts for the large majority of the increase in income inequality in the United States. It also accounts for at least a substantial part in other countries, as research conducted in the UK, Germany, and Sweden demonstrates. ... I believe that much of the rise of between-firm inequality, and therefore inequality in general, can be attributed to three factors: the rise of outsourcing, the adoption of IT, and the cumulative effects of winner-take-most competition."

In other words, a number of leading companies are now focusing on a very specific core competence. For other services, they hire outside contractors (either locally or long-distance). Bloom writes:

"Employees inside winning companies enjoy rising incomes and interesting cognitive challenges. Workers outside this charmed circle experience something quite different. For example, contract janitors no longer receive the benefits or pay premium tied to a job at a big company. Their wages have been squeezed as their employers routinely bid to retain outsourcing contracts, a process ensuring that labor costs remain low or go ever lower. Their earnings have also come under pressure as the pool of less-skilled job seekers has expanded, due to automation, trade, and the Great Recession. In the process, work has begun to mirror neighborhoods — sharply segregated along economic and educational lines."

The rise of between-firm inequality raises some social questions that go beyond the general issue of inequality between individuals. For example, it suggests that in the past, successful firms were more likely to have played a role in redistributing income, in the sense that all the employees of a successful firm tended to share, at least to some extent, in the firm's success. In the past, successful firms could offer a kind of career ladder, where a combination of experience and training helped some of their entry-level workers move up to middle-class jobs. In the past, successful companies offered a kind of integration across high-wage and low-wage jobs, because people in all kinds of jobs were more likely to have a common employer.

In contrast, a rise in between-firm inequality suggests that the US and other leading economies are becoming a more economically segregated, in the sense that those with high pay and those with lower pay are becoming less likely to have the same employer. It means that the classic "American dream" success story, of someone being hired in the mailroom or as a secretary or janitor, and then getting promoted up the company ladder, is less likely to occur. Nowadays, those jobs in the mailroom or the secretarial pool or the janitorial work are more likely to involve working for an outside contractor. In that sense, some of the rungs on the bottom of the ladder of success have been sawed off.