Why Income Inequality among White Collar Workers Is Growing
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Strategy Economics Jul 5, 2016

Why Income Inequal­i­ty among White Col­lar Work­ers Is Growing

Top earn­ers ben­e­fit most from knowl­edge hier­ar­chies” in organizations.

Lower earning workers in a "knowledge hierarchy" reach for opportunity

Yevgenia Nayberg

Based on the research of

Luis Garicano

Thomas N. Hubbard

Ris­ing income inequal­i­ty in the U.S. may seem like a 21st-cen­tu­ry pre­oc­cu­pa­tion, as work­ers agi­tate to occu­py Wall Street” from the left and to make Amer­i­ca great again” from the right. But the wage gap sep­a­rat­ing high-income Amer­i­cans from every­one else has actu­al­ly been grow­ing since the late 1970s, even as nation­wide pro­duc­tiv­i­ty and over­all wages have risen.

Tra­di­tion­al­ly, eco­nom­ic expla­na­tions of this trend have fall­en into two cat­e­gories. Some assign respon­si­bil­i­ty to poli­cies — for exam­ple, claim­ing that changes in tax pol­i­cy in the 1980s and ear­ly 2000s increased earn­ings inequal­i­ty. Oth­ers assign respon­si­bil­i­ty to changes in the sup­ply and demand for labor — for exam­ple, argu­ing that the long shift in the U.S. econ­o­my from man­u­fac­tur­ing to ser­vices may have boost­ed the demand for skilled work­ers rel­a­tive to unskilled workers.

Thomas Hub­bard, a pro­fes­sor of strat­e­gy at the Kel­logg School, has a dif­fer­ent idea. In two research papers coau­thored with Luis Gar­i­cano of the Lon­don School of Eco­nom­ics, Hub­bard makes a case that in addi­tion to tax pol­i­cy and labor-mar­ket shifts, orga­ni­za­tion­al effi­cien­cies have played a role in widen­ing the income gap.

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Over the past thir­ty years, there have been debates over whether it’s pol­i­cy or just sim­ple eco­nom­ics that has led to increas­es in earn­ings inequal­i­ty over time,” Hub­bard says. Now we’re say­ing that these changes may have every­thing to do with organization.”

Lever­ag­ing Human Capital

Hub­bard and Gar­i­cano iden­ti­fy an orga­ni­za­tion­al con­cept called knowl­edge hier­ar­chy” as respon­si­ble for a sig­nif­i­cant por­tion of income inequality.

The log­ic under­ly­ing a knowl­edge hier­ar­chy is fair­ly straight­for­ward: if a man­ag­er pos­sess­es a high lev­el of skill and insti­tu­tion­al knowl­edge, the firm can lever­age this skill and knowl­edge by allow­ing him or her to del­e­gate rou­tine work to cowork­ers with less knowl­edge. Knowl­edge hier­ar­chies, then, rep­re­sent a form of man­age­ment by excep­tion,” where only non­rou­tine prob­lems require man­age­r­i­al attention.

This rela­tion­ship between man­agers and those who report to them may be as old as busi­ness itself. But Hub­bard and Gar­i­cano were able to study its effects on pro­duc­tiv­i­ty and earn­ings inequal­i­ty with­in the con­fines of what they refer to as an unusu­al­ly clean lab­o­ra­to­ry,” eco­nom­i­cal­ly speak­ing: the law profession.

An attor­ney bring­ing home a six-fig­ure salary may not seem like a pro­to­typ­i­cal exam­ple of income inequal­i­ty in Amer­i­ca. But income inequal­i­ty is pro­nounced even with­in this rel­a­tive­ly well-com­pen­sat­ed field, and cer­tain struc­tur­al fea­tures of the pro­fes­sion made it a prime can­di­date for Hub­bard and Garicano’s analy­sis. For exam­ple, unlike com­plex cor­po­ra­tions and con­sul­tan­cies, law firms have two basic lev­els of orga­ni­za­tion — part­ners and asso­ciates — whose roles are defined con­sis­tent­ly across the whole pro­fes­sion, regard­less of firm size. And unlike more cap­i­tal-inten­sive con­texts such as man­u­fac­tur­ing, pro­duc­tion [in legal ser­vices] is most­ly about prob­lem solv­ing, and the two main inputs are lawyer skill and lawyer time,” Hub­bard explains. It’s a pro­fes­sion­al ser­vice indus­try neat­ly orga­nized in terms of func­tion, and we think it is a good metaphor for a lot of white-col­lar work.”

The boats are all being lift­ed, but some are being lift­ed by a lot more than others.”

Using data about 9,283 law prac­tices sam­pled from the 1992 U.S. Eco­nom­ic Cen­sus, Hub­bard and Gar­i­cano were able to show that lever­ag­ing attor­neys’ knowl­edge by orga­niz­ing in this way increased attor­neys’ pro­duc­tiv­i­ty by at least 30%. But orga­niz­ing through knowl­edge hier­ar­chies also ampli­fies earn­ings inequal­i­ty: most of the earn­ings gains from this increase in pro­duc­tiv­i­ty accrue to the most high­ly skilled attor­neys. Hub­bard and Gar­i­cano found that the 95th per­centile-earn­ing attor­ney in the U.S. earned about 50% more, a greater increase than that expe­ri­enced by low­er-earn­ing attorneys.

The Costs of Coordination

With this proof of con­cept, Hub­bard and Gar­i­cano set out to inves­ti­gate the effect of knowl­edge hier­ar­chies on earn­ings inequal­i­ty over a broad­er span of time. Sure enough, they found that earn­ings inequal­i­ty in the legal pro­fes­sion increased sig­nif­i­cant­ly between 1977 and 1992, as it became increas­ing­ly effi­cient to orga­nize in this way.

But what mech­a­nism caused the inequal­i­ty to widen?

Hub­bard rules out shifts in sup­ply and demand with­in the legal labor mar­ket, instead cit­ing a drop in what he calls costs of coor­di­na­tion.” Tech­no­log­i­cal advances, such as the legal search engine Lex­is and desk­top word proces­sors, made del­e­gat­ing rou­tine but knowl­edge-inten­sive parts of attor­neys’ work easier.

Put sim­ply, it was just awk­ward to del­e­gate work before these things hap­pened,” says Hub­bard. A lot of knowl­edge would be stuck with­in the partner’s head, so you had to talk to this per­son all the time. And if you’re spend­ing all this time talk­ing to this per­son to cre­ate the out­put, what’s the point in del­e­gat­ing it in the first place?”

In oth­er words, unavoid­able fric­tion in the com­mu­ni­ca­tion and coor­di­na­tion process­es with­in a firm would put a prac­ti­cal lim­it on how many clients a lawyer — even a top lawyer — could ser­vice per hour. But as tech­nol­o­gy increas­ing­ly aug­ment­ed the legal pro­fes­sion, del­e­ga­tion and col­lab­o­ra­tion with­in firms became more seam­less, and it became in top attor­neys’ inter­est to lever­age asso­ciates more inten­sive­ly than the medi­an attorney.

If you have an envi­ron­ment where it’s a lot eas­i­er to del­e­gate work to the asso­ciates than it used to be, you’d expect to see the best lawyers tak­ing more advan­tage of this than lawyers in the mid­dle of the [income] dis­tri­b­u­tion, because their skill is more valu­able to lever­age,” Hub­bard explains.

A Ris­ing Tide

While oth­er white-col­lar indus­tries may not be as clean-cut in their knowl­edge hier­ar­chies as the law, Hub­bard believes that the same mech­a­nism is like­ly increas­ing income inequal­i­ty in those pro­fes­sions. You’re talk­ing about man­agers who are essen­tial­ly human cap­i­tal­ists,” he says. They’re try­ing to fig­ure out a way to exploit economies of scale asso­ci­at­ed with their knowl­edge, and that’s been get­ting eas­i­er and eas­i­er over time.”

In oth­er words, the one-per­centers of the knowl­edge-work world can expect their earn­ings to pull ahead. Being more skilled is always bet­ter than being less skilled, because you have scarce tal­ent,” Hub­bard con­tin­ues. But now you also have a way to lever­age that tal­ent even more inten­sive­ly than you could before.”

So the mas­ter­minds will pros­per. But what do Hubbard’s find­ings imply about their associate’s prospects? Because of an increased util­i­ty to part­ners, the val­ue of their time is going up,” he says. And this is going to mean that their earn­ings will increase. Prob­a­bly not as much as the peo­ple at the top, though.”

There­in lies the rub. Falling coor­di­na­tion costs make knowl­edge hier­ar­chies more effec­tive, which increas­es gen­er­al pro­duc­tiv­i­ty and rais­es incomes — but inevitably widens the gap between top earn­ers and every­one else.

This is a tough one for pol­i­cy­mak­ers,” Hub­bard admits. This phe­nom­e­non is enabling pro­duc­tiv­i­ty increas­es, and you wouldn’t want to throw sand in the gears. But the chal­lenge is in the fact that the pro­duc­tiv­i­ty is being expe­ri­enced dif­fer­ent­ly by dif­fer­ent peo­ple. The boats are all being lift­ed, but some are being lift­ed by a lot more than others.”

Featured Faculty

Thomas N. Hubbard

Elinor and H. Wendell Hobbs Professor of Management and Faculty Director of Strategic Initiatives

About the Writer

John Pavlus is a writer and filmmaker focusing on science, technology, and design topics. He lives in Portland, Oregon.

About the Research

Garicano, Luis, and Thomas N. Hubbard. 2016. “The Returns to Knowledge Hierarchies.” Journal of Law, Economics and Organization.

Garicano, Luis, and Thomas N. Hubbard. 2016. “Earnings Inequality and Coordination Costs: Evidence from U.S. Law Firms.”  Working Paper.

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