Are Big Companies Driving Income Inequality?

Source: iStock
Source: iStock

The problem of income inequality is one that has grown over the years, at least in the amount of attention people are giving it. Cries of stopping the “1 percent” from gaining more wealth have increased, and providing for the middle class (and keeping a middle class at all) has been a key talking point for President Barack Obama, especially in his second term. Indeed, he’s called the growing disparity a “defining challenge of our time.”

And while the government might be able to start the conversation about income inequality, a new study suggests the root of the problem could lie at least partially with private corporations. Conventional economic wisdom about economies of scale says that workers at bigger companies should be more productive, and therefore earn more money. Theoretically, as The Economist points out, that should not automatically mean there’s also a rise in inequality. If the CEO and maintenance worker at a larger firm are both paid 10% more than their counterparts at a smaller agency, then the ratio between their wages should stay the same. In other words, the disparity between some of the lowest-paid and highest-paid workers in a company, regardless of size, should remain constant.

But theory doesn’t always equate to reality. The working paper, “Wage Inequality and Firm Growth,” distributed by the National Bureau of Economic Research, shows that benefits of scale are not disbursed equally among all workers at larger companies. If a larger company is making much more money than a smaller one, those extra profits often end up in the pockets of the CEO or other executives, not adjusted equally for all employees.

To study the inequality, researchers divided jobs of similar natures into nine categories per firm, and compared the differentials between top-wage earners and bottom-wage earners, compared to the size of the company. The researchers noted that their results were consistent, regardless of whether “size” referred to the firm’s sales or number of employees.

Source: The Economist
Source: The Economist

In total, the researchers used a sample size of 880 companies. And its results are clear for every country that is seeing significant company growth. “There is a positive and significant relation between rising wage inequality and employment growth by the largest firms in the economy,” the authors write. Plus, adding firm size to part of the regression analysis changes the results. “Thus, part of what may be perceived as a global trend toward more wage inequality may be actually coming from an increase in employment by the largest firms in the economy.”

The results of clear inequality in wages among larger firms carries through, regardless of industry in the United States and United Kingdom, where income inequality has been an issue since at least the 1990s. And the effects are enormous, the report contends, because the 500 largest firms in the United States have grown by 425% from 1980 to 2011. To sustain that growth, those larger companies have needed to hire more people, an idea backed up by U.S. Census Bureau data. Companies with 500 or more employees accounted for 51.5% of all employment in the country in 2011, a 13.2% increase in 20 years compared to the levels in 1988. As companies have grown, so has the income inequality within them. And as more people are employed by those companies, a greater percentage of people are also affected.

Part of the growing disparity in wages could be because executives at larger firms have more responsibilities than the CEO of a small startup. It takes more experience, and often more training, to manage an international corporation instead of a company with 50 employees and not as much overhead. Arguably, that would be reason enough for higher compensation. Another possible explanation, according to the researchers, is that lower-level “routine” jobs can often be automated, which allows larger companies with greater resources to keep those wages low. According to the researchers’ other hypothesis, lower-level workers at larger companies are also more willing to take lower compensation because of the better career opportunities a larger firm offers — perceived or otherwise.

Large firms going unchallenged

If the data from that report weren’t concerning enough, another business trend compounds the problem. Not only do larger corporations have the potential to affect wage inequality, but there’s also a rapidly diminishing number of startups to challenge that trend. The traditional view of business dynamism, or the constant churning of business birth, cycles, and death, is that a new company is born about every minute. Another one fails about every 80 seconds, according to the Brookings Institute. But a report from the institute in May 2014 shows that, based on most recent available data from 2011, that trend is flipping on its head.

For the first time in the 30-year period of collected data, the death of new businesses is outpacing the birth of new ones. In fact, the number of new businesses taking off has steadily declined since 1978, with the steepest drop-off during the recession. The economy is largely bouncing back from that period, but the rate of entrepreneurship is not. “It all feels pretty good,” Mark Zandi, chief economist at Moody’s Analytics, told The Washington Post. “But I think there are things to be worried about, and the state of entrepreneurship is one of those things.”

Source: Gallup
Source: Gallup

According to the most recent numbers, about 400,000 businesses begin each year, and roughly 470,000 die. Until 2008, startups outpaced dying businesses by about 100,000 per year, according to Gallup. To date, the net number of U.S. startups is -70,000. That figure has a toll on the comparison to other countries, as the United States now ranks 12th among developed nations in terms of business startup activity.

The Brookings Institute reports that the decline in entrepreneurship isn’t isolated to one region or industry. Firms and business owners seem to be more risk averse, and less likely to take chances by starting new companies. At a federal level, the Institute calls on the federal government to adopt more startup-friendly policies. One example, they suggest, is expanding the number of immigrant entrepreneurs who are granted permanent work visas. Allowing those people, often students, to stay and continue working in the country would likely spur on the number of new companies they attempt to build.

At a more local level, smaller governments, schools, and investors should be looking for “business accelerators” that encourage new growth. Finally, people at every level must not be afraid of some natural upheaval in the dynamism of business. “In a world in which other countries and citizens are improving their skills, products and services, the failure to change will only ensure continued decline,” the Institute writes — a continued decline that might persist even more rapidly, if the growth of large corporations is left unchallenged.

Follow Nikelle on Twitter @Nikelle_CS

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