USA

Why Pay Inequality Could Grow in Coming Years

Research from Professor Melanie Wallskog shows newer firms pay workers differently than older firms

OCTOBER 11, 2023

Finance

Pay policies of firms entering the market in recent years are showing a pattern that might forecast more inequality in the future. Research shows newer firms have higher levels of pay inequality than older firms.

Melanie Wallskog, an assistant professor of finance at Duke University’s Fuqua School of Business, examined payroll data from the U.S. Census Bureau and found that firms that entered the market after the 2010s are more spread out in how they pay their average workers than firms that entered in the past. And since pay-setting policies rarely change during the life cycle of companies, these findings might also imply a rise in earning inequality among workers in the coming decades.

In a live session on Fuqua’s LinkedIn page, Wallskog said U.S. pay inequality has slowly, but consistently, risen during the last five decades. Today, she said, if you randomly took 100 workers in the U.S. economy, the 10th highest worker would earn about 13 times higher than the 10th lowest worker. For context, it was nine times higher in the 1980s.

Wallskog said “70% of that rise in inequality” is the difference in pay in different firms, versus differences internally in organizations.

“It’s not the difference between how much CEOs make versus how much their firm’s average worker makes that explains most of the recent rise in inequality,” she said.

Wallskog also observed that the number of businesses entering the market every year has decreased in the last 25 years, and as a result each year a growing share of workers are employed in older firms. This means that as the most recent firms—those who pay their average workers differently—age and take up the largest share of employment, “pay inequality will likely rise in the future,” she said.

Wallskog has several reasons that might explain why newer firms are more unequal. Newer entrants might pay similar workers differently, she said, or they might hire different workers. They might also specialize in technologies and processes that result in lower pay.

“Changing technologies affect how labor is used and therefore how labor is remunerated,” she said.

Newer firms also specialize in whom they hire, she said. For example, some firms might only hire college-educated workers, which Wallskog says produces more pay inequality across firms.

Other macrotrends affecting inequality include the practice of outsourcing workers, the changing of norms about sharing profits with workers, and the decline in unionization, Wallskog said.

“However, I don't think that unionization decline is driving the vast majority of this trend,” she said. “The rise in pay inequality among newer entrants is common across all different types of sectors, not just sectors where unions have declined.”

All these macrotrends, Wallskog said, shape whom the newer firms hire and how they pay them.

“Firms fundamentally choose their compensation structure and the types of workers they hire when they enter,” she said. “And will stick to them over time, because managerial decisions tend to be sticky.”

Inequality matters, Wallskog said, and has important consequences on general welfare—especially in the U.S., where workers’ benefits are tied to their employment status and “things like health insurance, flexibility, or parental leave tend to be better at higher paying firms,” she said.

Regulation could play a role in reducing pay inequality, she said. “For example, a policy that limits offshoring and forces companies to hire more American workers would likely reduce inequality,” she said.

Wallskog believes regulation might be more effective on the benefits side of compensation.

“People getting increasingly cut off from firms that don't have good health care might be an argument for universal health coverage,” she said.