Inequality and Labor Market Institutions

Abstract

The rise of inequality in advanced economies, and in particular the growing concentration of incomes at the top of the distribution, has become a greater focus of attention for economists and policymakers. Understanding the factors behind this phenomenon is essential to determine whether policy action is needed to reduce income inequality, taking into account other policy objectives. Traditional explanations advanced for the rise in inequality have been technological progress and globalization. But there is little policymakers are able or willing to do to reverse these trends, because they benefit growth. Moreover, while high-income countries have been similarly affected by technological change and globalization, inequality in these economies has risen at different speeds. This has led economists to underscore the role of institutional changes, notably of financial deregulation and lower top marginal personal income tax rates. This paper takes a fresh look at the causes of the rise of inequality in advanced economies, focusing on the relationship between labor market institutions and the distribution of incomes—which has featured less prominently in recent debates. We find evidence that the erosion of labor market institutions is associated with the rise of income inequality in our sample of advanced economies, notably at the top of the income distribution. Our key findings are that the decline in unionization is related to the rise of top income shares and less redistribution, while the erosion of minimum wages is correlated with considerable increases in overall inequality. There is also some evidence that the broad extension of collective agreements to non-union members is associated with higher inequality, likely owing to higher unemployment. Finally, we confirm that financial deregulation and lower top marginal tax rates are related with higher inequality.