The patterns and determinants of changes in inequality are subjects of perennial interest to economists and policymakers alike. In particular, a vast literature has sprung up that has documented various aspects of the sharp rise in wage inequality that occurred in the U.S. in the 1980s and that continued, although at a much lower rate, in the 1990s (e.g., Juhn, Murphy, and Pierce, 1993; Buchinsky, 1994). The reasons for this rise in U.S. wage inequality have also been studied extensively, with a large body of evidence suggesting that the proximate cause can be traced to increases in the relative demand for high-skill versus low-skill labor, attributable to skill-biased technological change (e.g., Katz and Murphy, 1992; Bound and Johnson, 1992). Nevertheless, the debate on the quantitative importance of trade patterns rather than technological shifts in explaining rising wage inequality continues to be contentious (see Leamer, 2000; and Krugman, 2000, for opposing views on this matter). Whatever the reasons for the rise in wage inequality, it is undeniably a key characteristic of labor market developments in the U.S. over the last three decades and suggests that the U.S. wage structure is quite sensitive to market forces.
The U.S. is often considered the epitome of labor market “flexibility,” in counterpoint to the rigid labor markets of many countries in continental Europe. Some authors have argued that, in response to skill-biased technological change that is a well-documented phenomenon across all industrial countries (Machin and Reenen, 1998), relative wages have borne much of the burden of adjustment in the U.S., resulting in rising wage inequality. In continental Europe, by contrast, institutional rigidities—including wage bargaining structures—have constrained potential increases in wage inequality; hence, labor market adjustment has occurred through significant divergences in relative unemployment and employment rates for skilled and unskilled labor (see, e.g., Siebert, 1997). The U.K. represents an interesting intermediate case of a labor market that, especially after the Thatcher-era reforms, has moved in the direction of U.S.-style flexibility. Examining the evolution of wage inequality in the U.K. is therefore of interest in terms of this broader debate as well.1
A number of papers have explored changes in wage inequality in the U.K. in the 1980s and early 1990s (see, for example, Gregg and Machin, 1994; Machin, 1996, 1998; Gosling, Machin, and Meghir, 2000; and references therein). The general consensus in most of this work is that there was a significant increase in wage dispersion during the 1980s and a continued increase, although at a more moderate rate, during the early 1990s. This paper builds upon this earlier work, and its first contribution is to update these results to include the latter half of the 1990s. Labor market and other institutional reforms undertaken in the Thatcher era have been implicated by some observers as being responsible in large part for the rising wage dispersion witnessed in the 1980s and early 1990s. Hence, it is of interest to see what the longer-term effects of these reforms have been in the context of a period of strong employment growth and low unemployment, as was witnessed in the U.K. in the latter half of the 1990s.
The paper also includes an examination of changes in within- and betweengroup inequality and their contributions to changes in overall inequality. A number of recently developed theoretical models have proposed that increases in between-and within-group inequality are different manifestations of the same factors, which are mostly related to technological change (see, for example, Aghion, Hewitt, and Violante, 2000; and Galor and Moav, 2000). This literature has largely been based on existing stylized facts for the U.S. Hence, it is of interest to examine if other relatively “flexible” labor markets have witnessed similar patterns of changes in the different components of overall inequality.
Another important issue is whether changes in the structure of employment have influenced the evolution of wage inequality. Although wages and employment are jointly determined both at the aggregated and disaggregated levels, exogenous shifts in the structure of employment can, as an accounting matter, have a significant impact on wage inequality. An additional contribution of this paper is a careful analysis of the effects of shifts in the structure of employment—in a variety of dimensions—on changes in wage inequality.
A striking phenomenon in the U.K. labor market over the last two decades, as in many other industrial countries, has been the increasingly important role of women in terms of labor force participation and employment. A related development is the rising share of part-time employment—largely concentrated among women—in total employment. This paper also examines the quantitative influence of these phenomena on the evolution of wage inequality.
One of the main results in the paper is that there was virtually no change in wage inequality in the U.K. in the latter half of the 1990s. This is in sharp contrast to the increases in inequality that were witnessed during the 1980s and, to a lesser degree, in the first half of the 1990s. Increases in within-group inequality appear to have been the major determinant of changes in overall inequality during these earlier periods. However, both components of inequality have been essentially flat since the mid–1990s.
Marked shifts in the industrial and occupational structures of aggregate employment over the last 25 years have contributed to the total increase in U.K. wage inequality, although increases in inequality within broadly defined industries or occupation groups still remain, in quantitative terms, the most important determinant of overall inequality. Another interesting result is that there has been a convergence of the wage distributions for men and women over this period, resulting in more stability in the overall wage distribution than for either of these groups taken separately.
Since the focus of the paper is on cross-sectional inequality, certain other aspects of changes in inequality in the U.K. are not examined. These include the relative importance of the permanent and transitory components of inequality and the related issue of mobility within the income distribution.2 In addition, given the constraints of the dataset, it is not possible to analyze broader composition effects, especially in terms of unobserved worker attributes, on the evolution of wage inequality (see, for example, Blundell, Reed, and Stoker, 1999).
Aghion, Philippe, Peter Howitt, and Gianluca Violante, 2000, “General Purpose Technology and Within-Group Inequality” (unpublished; London: University College, University of London).
Blundell, Richard, H. Reed, and Thomas Stoker, 1999, “Interpreting Movements in Average Male Earnings: The Role of Labor Market Participation,” IFS Working Paper No. 99/13 (London: Institute for Fiscal Studies).
Bound, John, and George Johnson, 1992, “Changes in the Structure of Wages During the 1980s: An Evaluation of Alternative Explanations,” American Economic Review, Vol. 82, pp. 371–92.
Buchinsky, Moshe, 1994, “Changes in the U.S. Wage Structure 1963–1987: Application of Quantile Regression,” Econometrica, Vol. 62, pp. 405–58.
Dickens, Richard, 2000a, “The Evolution of Individual Male Earnings in Great Britain,” The Economic Journal, Vol. 110, pp. 27–49.
Fortin, Nicole M., and Thomas Lemieux, 2000, “Are Women’s Wage Gains Men’s Losses? A Distributional Test,” AER Papers and Proceedings, Vol. 90, pp. 456–60.
Galor, Oded, and Omer Moav, 2000, “Ability-Biased Technological Transition, Wage Inequality, and Economic Growth,” Quarterly Journal of Economics, Vol. 115, pp. 469–97.
Gosling, Amanda, Stephen Machin, and Costas Meghir, 2000, “The Changing Distribution of Male Wages in the U.K.,” Review of Economic Studies, Vol. 67, (October), pp. 635–66.
Gregg, Paul, and Stephen Machin, 1994, “Is the Rise in U.K. Inequality Different,” in The U.K. Labor Market: Comparative Aspects and Institutional Developments, ed. by Ray Barrell (Glasgow: Bell and Bain, Ltd.).
Juhn, Chinhui, Kevin M. Murphy, and Brooks Pierce, 1993, “Wage Inequality and the Rise in Returns to Skill,” Journal of Political Economy, Vol. 101, pp. 410–42.
Katz, Lawrence F., and Kevin M. Murphy, 1992, “Changes in the Wage Structure: Supply and Demand Factors,” Quarterly Journal of Economics, Vol. 107, pp. 35–78.
Lee, David S., 1999, “Wage Inequality in the United States During the 1980s: Rising Dispersion or Falling Minimum Wage?” Quarterly Journal of Economics, Vol. 114, pp. 977–1023.
Machin, Stephen, 1998, “Recent Shifts in Wage Inequality and the Wage Returns to Education in Britain,” National Institute Economic Review, Vol. 166, pp. 87–95.
Machin, Stephen, and John Van Reenen, 1998, “Technology and Changes in Skill Structure: Evidence from Seven OECD Countries,” Quarterly Journal of Economics, Vol. 113, pp. 1215–44.
Nickell, Stephen, and Brian Bell, 1996, “Changes in the Distribution of Wages and Unemployment in OECD Countries,” American Economic Review, Vol. 86, pp. 302–08.
Prasad, Eswar S., 2000, “The Unbearable Stability of the German Wage Structure: Evidence and Interpretation,” IMF Working Paper 00/22 (Washington: International Monetary Fund).
Siebert, Horst, 1997, “Labor Market Rigidities: At the Root of Unemployment in Europe,” Journal of Economic Perspectives, Vol. 11, pp. 37–54.
Eswar S. Prasad is Assistant to the Director in the Research Department of the IMF. I am grateful to the Office for National Statistics, U.K., for providing the New Earnings Survey (NES) data and, in particular, to Nigel Studdard and Tiara Roy for help in using the dataset. I would also like to thank Richard Dickens, Julio Escolano, and numerous colleagues and seminar participants at the IMF for helpful discussions and Stefan Hubrich for efficient research assistance. An anonymous referee provided useful comments that helped sharpen the exposition.
Dickens (2000a) finds that increases in the permanent and temporary components of inequality are about equally responsible for the increases in male wage inequality over the period 1975–95. In subsequent work (Dickens, 2000b), he finds evidence of very limited short-term (year to year) mobility within the wage distribution and also reports that wage mobility has declined from the late 1970s to the mid–1990s.
See Dickens (2000a) for more details on the NES dataset and for a comparison of this dataset with Labour Force Survey data on low-wage workers.
The use of the RPI-X or the private consumption deflator made little difference to the results reported in this paper.
This four-group classification is based on one-digit industry codes as follows: Manufacturing (metal manufacturing; textiles, leather, clothing; other manufacturing); Construction, utilities, and transportation (construction; gas, electricity and water; transport and communications); Trade and services (retail and wholesale trade; financial and professional services; other services); Public administration. Excluded from this classification are agriculture, forestry, and fishing; mining and quarrying; and food, drink, and tobacco. Together, these three industries account for only about 6 percent of total employment.
This four-group classification is based on regional codes as follows: North (North East, North West, Merseyside); Midlands and Eastern (East Midlands, West Midlands, Eastern); London and South (London, South East, South West); and Wales and Scotland.
The shift in inequality in 1991 for skilled manual workers partly reflects a change in coding that made it difficult to obtain a perfect match for the pre- and post–1991 occupational codes.
This approach was popularized by Juhn, Murphy, and Pierce (1993). Using this technique, these authors show that, in the U.S., both within- and between-group inequality rose sharply among men during the 1980s.
This weighting procedure is similar to that employed by Fortin and Lemieux (2000). The kernel density estimates for log hourly wages were computed using an Epanechnikov kernel with bandwidth set to 0.05. These density estimates were also computed using optimal bandwidths computed separately for each year—these bandwidths were typically in the range of 0.04–0.06. Using optimal bandwidths had little effect on the shape of the distributions. The use of a fixed bandwidth is solely to maintain consistency when comparing distributions across different years.
Fortin and Lemieux (2000) document a similar phenomenon in the U.S. They argue that this helps reconcile two findings. One is that male wage inequality has increased sharply in the U.S. in the 1980s and, although at a slower rate, also in the 1990s, with both within- and between-group inequality among men contributing to this increase (see, for example, Juhn, Murphy, and Pierce, 1993). The second result, documented by Lee (1999), is that the overall wage distribution in the U.S., including both men and women, was actually quite stable in the 1980s and 1990s, once the effects of the decline in the real value of the minimum wage are controlled for.
In addition, the dispersion of annual earnings could differ from that of monthly earnings. However, the NES does not have information on annual earnings (or on the number of months of employment per year).
The results reported in Table 5 are for 5–year cohorts and are based on the full sample that includes both full-time and part-time workers. Results based on 10–year cohorts or on a restricted sample limited to full-time workers made little difference to the main conclusions.
Self selection into retirement probably accounts for the decline in inequality among older workers.