I don't recall reading much discussion of "Performance Pay and Wage Inequality", a paper by Thomas Lemieux, W. Bentley MacLeod, and Daniel Parent, either when it was released as an NBER working paper in 2007 or when it was published in the Quarterly Journal of Economics in 2009 (ungated pdf here). That's too bad, because it is an important paper and does more than any other to answer the perennial question "What has caused the increase in income inequality in the U.S. since the 1970s?" Almost all of the shift in income distribution over that period has accrued to the top 10% of workers, but it hasn't been clear why. Some have argued that the increase in inequality was caused by increased trade openness, changing cultural norms rewarding greed, the decline of labor unions, skill-biased technological change, shifting tax policy that rewarded the rich, and/or increasing returns to economic "superstars" like entertainers and athletes.
The authors make a pretty strong case that it has been because employers have become better able to find and reward more-productive workers for their work, while less-productive workers are left behind. (This is largely consistent with the "skill-biased technological change" explanation, though more specific in theory and causal mechanism.) The abstract:
An increasing fraction of jobs in the U.S. labor market explicitly pay workers for their performance using bonus pay, commissions, or piece-rate contracts. Using data from the Panel Study of Income Dynamics, we show that compensation in performance-pay jobs is more closely tied to both observed and unobserved productive characteristics of workers than compensation in non-performance-pay jobs. We also find that the return to these productive characteristics increased faster over time in performance-pay than in non-performance-pay jobs. We show that this finding is consistent with the view that underlying changes in returns to skill due, for instance, to technological change induce more firms to offer performance-pay contracts and result in more wage inequality among workers who are paid for performance. Thus, performance pay provides a channel through which underlying changes in returns to skill get translated into higher wage inequality. We conclude that this channel accounts for 21% of the growth in the variance of male wages between the late 1970s and the early 1990s and for most of the increase in wage inequality above the eightieth percentile over the same period.
In other words, workers that have earned more have largely deserved to earn more, by objective criteria. Employers have become better at discovering top performers and compensating them accordingly. Top employees have become better at finding ways to demonstrate to employers what their true value is. Over time, more jobs have included performance pay as some or all of their compensation, so inequality has increased. The striking thing is that this explains almost all of the inequality increase in the 80th percentile and above, which is where almost all of the increase in inequality has occurred. It's a powerful paper.
This isn't as sexy or sinister as other narratives of increasing inequality, but it makes sense. Technology has made it easier to demonstrate and assess productivity, especially in information-intensive professions. The information technology sector has increased relative to traditional salaried sectors like manufacturing. Hence, inequality has increased.
I'm amazed that this wasn't covered more in blogosphere. Is it because it contradicts some sacred cows?
Anyway the news that the American political economy is not unjustly controlled by the rich using their power to extract rents should be welcomed by everyone. In other words, we should be very pleased that we do not live in a "New Gilded Age", at least if that's defined by robber-barons seizing wealth that they were not entitled to. This paper is evidence that the wages are distributed more fairly than most of us had thought.