As we try to understand the turbulent state of our economy and politics, the role of income inequality and the associated wealth gap in Western societies remains the source of considerable debate.
Progressives claim that unequal outcomes reduce social mobility, weaken social cohesion, and contribute to the general state of political dysfunction. Conservatives, on the other hand, make different arguments, including that inequality has stabilized, or that it reflects life cycle trends, or that it doesn’t matter anyway.
I have made versions of the latter arguments over the years. My main argument was that unequal outcomes are not generally a problem to be solved in a market economy and that public policy should instead aim to expand opportunities as much as possible. In other words, policies should aim to encourage greater social mobility rather than attempting to offset outcomes through greater levels of redistribution.
But what if both sides are right? More precisely, the truth lies somewhere in the middle – namely in the middle of the skill distribution in the labor market. Let me try to explain.
The main problem with the Left’s analysis of inequality is that it misinterprets the causes. His arguments tend to imply something corrupt, greedy, or systematic about the unequal outcomes in our society. In this way, we have largely managed to allow the language of “privilege” to permeate modern political discourse. It is no longer a matter of political considerations, but a moral enterprise designed to overthrow generations of social arrangements, including in some cases the market economy itself.
The whole “tax-the-rich” movement therefore often seems to regard higher taxes as an end in themselves. The talk by leading progressives like Thomas Piketty of “taxing billionaires out of existence” is a bit of a telltale. The argument for confiscatory taxes is often presented implicitly as a means of equalizing downwards rather than as part of an overall plan to boost low-income individuals or households.
Notwithstanding the inherent flaws in these arguments, it would be a mistake to underestimate their political significance. According to polls, Canadians, Americans and other Westerners generally support higher taxes for high-income people.
This has manifested itself in growing political action. In Canada, for example, we have seen a series of federal and provincial redistributive tax reforms, including new and higher tax rates for high earners, a redistributive carbon tax and cash transfers, and new taxes on capital and now luxury goods.
But while the left has been wrong in how it thinks about the causes and right answers to income inequality, over the past few years I’ve come to understand that its fundamental insight is not entirely wrong. Structural changes in our labor market – particularly the relative decline in middle-skilled jobs – are far more responsible for income inequality than any nefarious agent. In particular, the decline in manufacturing employment is an important factor in understanding what has been termed the “hourglass economy”.
The basic idea is that the old manufacturing economy produced a more egalitarian labor market, with most jobs in and around the middle of the skill distribution. In contrast, today’s service-based economy is much more divided into low-paying and often low-skill jobs in nursing or personal services and high-paying and often high-skill jobs in professional, administrative and financial services. This labor market development is often referred to as “job polarization”.
It has appeared in all Western economies over the past 30 years. Canada is no exception. Between 1989 and 2019, the Canadian economy experienced a 6 percentage point decline in the relative share of medium-skilled jobs (see Figure 1). That number rose to 7.5 percentage points in Ontario and Quebec, where there was a high concentration of manufacturing jobs, which had historically been a significant source of middle-class opportunities.
These labor market developments have significant implications for political economy, including for the broader debate on income inequality. If the relative share of middle-skilled jobs falls, many may move up the skill distribution to higher-skilled jobs, but some inevitably fall down to lower-skilled jobs. The income consequences can be significant: employees in highly qualified occupations earn almost four times as much as employees in low-skilled occupations. The result is that we end up with a more bifurcated labor market in which unequal outcomes can become increasingly entrenched.
A major exception to these trends over the past two decades has been the preoccupation with natural resources. Indeed, research shows that job polarization in Canada was less pronounced than in comparable jurisdictions, as the resource sectors in general and the oil and gas sector in particular had significant labor needs for medium-skilled workers and therefore a “low-wage employment alternative”. represented service occupations”.
This point cannot be overemphasized: as the labor market has undergone a process of polarization in the 21st century, employment in natural resources has generally bucked this trend, thereby empowering Canada’s middle class. As economist Kevin Milligan of the University of British Columbia put it: “The resource sector has been a major contributor to the good jobs that underpin the resilience of the middle class.”
Two important policy lessons can be drawn from this analysis. First, it should challenge the simplistic view that income inequality is caused by unequal economic forces and that the best policy response is therefore greater redistribution in the tax and transfer system. This prevailing but erroneous interpretation focuses too much on the symptoms of inequality rather than aiming to properly understand and address the underlying cause of an increasingly bifurcated labor market where unequal outcomes are something of a natural consequence.
The best way to address income inequality in the modern labor market is to create a new generation of middle-class opportunities to replace those that have disappeared over the past few decades through a combination of technology and trade. Put simply, this amounts to a “Good Jobs” agenda that aims to transform today’s low-skilled jobs into tomorrow’s medium-skilled jobs by moving low-skilled workers up the skills ladder through education, training and productivity-enhancing investments . The key point here is that a new generation of good jobs will ultimately emerge from a mix of public and private investment in human and technological capital, rather than from state-led redistribution.
The second finding is that policymakers should be aware of the anti-inequality role that resource-based employment plays in the Canadian labor market. Of course, that doesn’t mean we shouldn’t pursue ambitious climate policies, including potentially high emissions standards for resource-based companies. But it does mean that we should be more aware of the impact of climate policies on employment and the extent to which they can lead to more job polarization and, in turn, contribute to more inequality.
This assessment seems particularly important for progressives, who often call for both tougher climate policies and greater action on inequality. As Milligan has argued, “For Canadians concerned about inequality, the leveling effect of resource development on our economy is too powerful to ignore.”
The main point, however, is that understanding the current state of inequality through the lens of job polarization should shift the focus of our policy debates from taxing the rich to creating the next generation of good middle-class jobs. That would be a healthy development for our economy and politics.