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IZA World of Labor explains inequality

This video explains what economic inequality is, why it matters and what causes it. It also offers suggestions on how inequality can be reduced. Inequality affects what we do and how we perceive the rest of the world, in every aspect of our daily lives. So find out more: https://wol.iza.org/key-topics/economic-inequality

What is inequality?
Economic inequality means some people, some households, are earning more than others or have incomes above others. It can be fairly equal—some people making more and others having much less—or much less equal—with a few people making huge amounts, others making some and large numbers making very little. Inequality has varied over time—right now, it’s at the highest level for 80 years in the US and that also seems to be true in much of Western Europe.

Why does inequality matter?
The more unequal a society is, the greater the chances it’s less socially cohesive—more feelings that there are others who are different from us. This leads to instability and more visible conflict. We see this today with the rise of populism in Western Europe and the US.

What causes inequality?
Inequality of economic outcomes is caused by a variety of things including lack of opportunities for jobs, longer term unemployment, and perhaps, most of all, lack of opportunities for education. The biggest single thing that causes people to do better economically is the amount of education they have. So, if education isn’t readily available for many people, we’ll find more inequality. Some economies offer much higher pay at the top than others. In the US in particular, there are huge rewards for being near the top of the pay distribution. In the last 15–20 years we’ve seen widening inequality due to the people at the very top doing much much better than they had previously and compared to those who are less well paid. And changes in these things are the main causes of changing inequality in Western societies.

How can we reduce inequality?
There are numerous ways to reduce inequality and governments already do this with various policies. Transfer payments—from governments to individuals depending on their income status. These may equalize income across households. Also, governments tax households. In most countries including even the US, on net, taxes are proportionately greater on higher-income households thus redistributing income toward lower income households. The extent to which countries do this will help reduce the amount of inequality after taxes in those societies and therefore also spending inequality.

So, in summary
Inequality of incomes matters—it affects what we do, how we perceive the rest of the world, in every aspect of our daily lives.

Daniel Hamermesh - Labor costs

Daniel S. Hamermesh, Editor-in-Chief at IZA World of labor, discusses labor costs.

By how much does employment fall when labor costs increase?
It’s a very hard question to figure out how much employment will respond to a rise in labor costs, and it clearly depends on the kind of worker. For high skilled workers, a rise in labor costs doesn’t make much difference. For lower skilled workers, employers are more responsive and will cut back employment more. On average, my best guess is, ten per cent rise in labor costs. Everything else the same, nothing else changes, will lead to about a three per cent drop in employment in hours.

How rapidly do employers adjust to an increase in labor costs?
Clearly there’s an initial response that takes quite a while for things to be fully realised. For lower skilled workers, the evidence is very clear, the responses are fairly quick: a quarter or two quarters. For higher skilled workers, it takes much longer. I mean think about professors, it’s very hard, even if their wages rise and their costs rise, to get rid of them. It takes a long time before some will retire, and you don’t hire their replacements. So it depends very, very much on the skill. On average, perhaps half of any adjustment would be made up in six months.

How do employers choose whether to cut employees or hours? 
Remember that total work is the product of the number of workers times the number of hours. Now think about, it if you’re a smart employer, you spend a lot of money training workers, searching for workers, and if you fire them you’ve got to pay them unemployment compensation. So typically, the first response is to cut the hours of existing workers. It’s only after you’ve cut hours somewhat that it pays you to start thinking about getting rid of workers, and even then, you won’t get rid of workers, you’ll just stop hiring workers when others quit. So if hours are the first margin of response, employees are the second margin of response, and within that margin you’ll work off the margin of non-replacement rather than firing people.

Pierre Cahuc - Short-term work compensation

Pierre Cahuc, Professor of Economics, ENSAE-CREST, Ecole Polytechnique, discusses short-term work compensation.

Short-term work has been a policy that has been widely used in Germany and in many countries during the recession and the question is to whether it improves employment. There has been some research looking at that and the answer is definitively yes. There is an improvement in employment, especially for firms that face credit constraint and so these types of firms survive and recover faster. So. there is some empirical evidence about that, we need to do more, but today this is what we know about this.

Who benefits the most from work compensation?
Everyone does not benefit in the same way from short-term work. Obviously permanent workers benefit more because they are those who are usually involved in this kind of programmes. Temporary workers usually go from job to job, they benefit less, and even this can be counterproductive for them because it can be more difficult for them to be recruited because permanent workers are more protected than when on a short-term programme.

Under what conditions should short-term compensation be used?
Short-term workers should be used during recessions when firms find it difficult to find funds to keep workers. In normal time short-term work is much less useful because firms have more access to credit and it’s easier for them to develop projects and to keep workers. So, short-term work should be used in a recession but much less in normal time.

In addition, policymakers should be aware that firms should not repeatedly use short-term work because there is a risk to a firm that they are not very productive, and we need to have quality firms, ones that increase profits and they increase productivity.

From that point of view, it’s important that there is some expert rating in short-term work, meaning that firms that get short-term work compensation have to repay, reimburse to some extent the costs of these programmes when they are in better condition.

Astrid Kunze - Why do women fall behind men

Astrid Kunze, Professor of Economics at the Norwegian School of Economics, discusses why women fall behind men.

Why do women fall behind men in terms of career prospects and wages?
I think this is a very good way of asking about the sources of gender wage gap, to think of when does the gender wage gap arise. If you think about careers over time, it’s important that we follow them over education, and then there’s the first entry into the labor market. That’s the first time we observe wages for men and women.

Then they continue working, then the next big event we observe in careers is when people form families and they have their first child, and then afterwards they may continue working or have further children. So what we observe is really that there is an entry wage gap.

There’s some variation, some studies find actually no gender wage gap when we look at men and women with similar education, but quite a body of research still finds that also at entry already women enter the lower wage than men. So that’s the first source of gender wage gap.

Then as men and women work, usually as single and without children, we also observe actually that the gender wage gap increases already. So by the time they have their first child, there are already two reasons why there may be a wage gap.

But then we see a further and even larger increase in the gender wage gap because women, after first birth, go down in terms of wages. For men, on the contrary, we tend to observe that they stay on the same wage track or even increase wages, which may be due to several factors.

Also, of course the fact that women go down is related to parental leave that has become institutionalised more and more in countries and its job protected, so there has been a lot of progress to ensure that women can return to their previous job after birth.

But then over time after the birth, we actually observe which is quite noteworthy that women never catch up. You may think as children grow older, women can return to their previous career tracks, especially if you think of high skilled lawyers, people with very high university education, but we seem not to observe this. So the gender wage gap prevails over the life cycle.