Is Income Inequality An Inevitable Consequence Of Differing Employee Education Levels?

Against the backdrop of increasing income inequality in many developed countries in recent decades, a recent study analyzed Danish private sector data from 1992 to 2007 to determine the level and trends of income inequality during that period. The results confirmed that income inequality increased in Denmark during this time. The researchers also found that the relative proportion of highly educated individuals increased, as did income growth rates across various employee subgroups, with managers seeing a particularly significant real income progression. Education and Management income premiums were found.

Key Topics: Income inequality; Upskilling; Education; Management pay

Title of Reviewed Article: Income Inequality: The Consequences Of Skill-Upgrading When Firms Have Hierarchical Organizational Structures
 
Researchers: Anders Frederiksen (Aarhus University) and Odile Poulsen (University of East Anglia).
 
Publication: Economic Inquiry, 2016, Vol. 54 No. 2, pp. 1224–1239.

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Setting the Scene
 
Over the past few decades many developed countries have seen increasing income inequality, with traditionally low inequality countries such as Sweden, Germany, and Denmark also experiencing significant increases (OECD, 2011). Consistent with these findings, Atkinson and Søgaard (2013), found that income inequality had changed significantly during the last 140 years in Denmark.
 
Prior research in the US has highlighted the role of skill-upgrading and management compensation as catalysts for income inequality (e.g. Juhn, Murphy, & Pierce 1993; Katz & Autor 1999). Research suggests that the significant widening of US beginning in the 1980’s correlated with the growth in the supply of highly educated workers in the US.
 
The current research looks to further investigate these relationships by examining, through the development of a theoretical model, the interplay between management compensation, skill-upgrading, and income inequality.
 
How the research was conducted
 
The researchers conducted this study by analyzing Danish Register based employer and employee data from 1992 to 2007. This database contained detailed information on all private sector employees and companies, which could be matched to each other. The database contained >1 million annual observations, resulting in an approximate total of 18 million person-year observations.
 
For analysis, the researchers divided the sample into four distinct employee subgroups, namely, less-educated managers, highly educated managers, less-educated non-managers, and less-educated non-managers.
 
To investigate income inequality further, the researchers developed a theoretical model, to examine the interplay between management compensation, skill-upgrading, and income inequality. This model was developed with reference to similar prior models (e.g. Dolado, Jansen, & Jimeno, 2009), which similarly classified workers based on level of education and complexity of jobs.
 
Key Research Findings
 
Results found that income inequality increased in Denmark during 1992 and 2007. Over this period, real income was found to increase by 14.29%, or approximately 1% annually. However, this increase was found to be non-uniform across the subgroups.
 
All of the employee subgroups saw real income progression over the review period, although management compensation was found to have grown at a significantly higher rate than other subgroups.
 
During the review period, there was an increase in highly educated workers in the labor market. At the beginning of the review period, 9% of the labor force were highly educated, with this figure increasing to 18% by 2007.
 
The results found that income increases with both education and job level. These results show that a combination of skill upgrading, via greater education, and increasing management compensation can explain a significant part of the increasing income inequality observed.
 
Results Commentary
 
The changes in Danish income inequality share many of the characteristics observed in other Western countries over a similar period, but what is clear from the results is that there is no one factor driving the growth of income inequality, but rather a combination of factors. While real income increases in non-management jobs were relatively small, at 2% for highly educated employees and 10% for less educated, management income increased at a much greater rate of 27% for highly educated employees and 31% for those less educated.
 
The rise in highly educated employees is notable, as they not only became more prevalent generally, but also took up a greater proportion of managerial roles as the period progressed, with the size of the less-educated management subgroup decreasing by 27%, suggesting that higher education is increasingly becoming a prerequisite for managerial positions.
 
The researchers point to the fact that the results indicate the presence of both a ‘management premium’ and an ‘education premium’, with these groups being more generously compensated. The researchers argue that the management premium is based on the assumption that managers are more productive and have longer tenures. On the other hand, the education premium may be based on the assumption that more educated employees have the potential and likelihood of having more complex jobs.
 
Organizational and Reward Implications
 
From a company perspective, it is important to be aware of the behaviors that lead to income inequality, such as applying management and education premiums. Given the role of companies in generating income inequality, they should ensure their compensation practices are consistent with their company values and ethos.
 
Final Thoughts
 
This study, while providing valuable information on Danish income inequality, also provides interesting analysis on some of the factors impacting income inequality generally, namely managerial and educational status. While the study results show similarities to those in other Western countries, future research would benefit from the replication of this study in other countries to further determine the generalizability of results.

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Source Article: Frederiksen, A., & Poulsen, O. (2016). Income Inequality: The Consequences Of Skill-Upgrading When Firms Have Hierarchical Organizational Structures. Economic Inquiry, 54(2), 1224-1239.
 
Published by: Western Economic Association International
 
For further details and access to the full journal article Click Here (subscription or payment may be required).

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References:
 
Atkinson, A. B., & Søgaard, J. E. (2013). The Long-Run History of Income Inequality in Denmark: Top Incomes from 1870 to 2010. EPRU Working Paper Series 2013–01, Copenhagen University, Denmark.
 
Dolado, J. J., Jansen, M., & Jimeno J. F. (2009). On-the-Job Search in a Matching Model with Heterogeneous Jobs and Workers. The Economic Journal, 119(534), 200–228.
 
Juhn, C., Murphy, K. M., & Pierce, B. (1993). Wage Inequality and the Rise in Returns to Skill. Journal of Political Economy, 101(3), 410–42.
 
Katz, L. F., & Autor D. H. (1999). Handbook of Labor Economics. Amsterdam, The Netherlands: Elsevier.
 
OECD. (2011). Divided We Stand: Why Inequality Keeps Rising. Paris: OECD Publishing.