Why compensating differentials might mean that inequality has been decreasing over time

John McGinnis wrote an interesting piece earlier in the month, on why compensating differentials likely temper any growth in income inequality. John writes:

This simple observation suggests that focusing only on earned income from employment can provide a misleading picture of  any growth in inequality.Overall satisfaction from a job comes not only from earnings but also from the amenities it provides and the risks it presents.  If our economy is improving lower income jobs by reducing risks and providing a more enjoyable environment this trend could compensate for at least some of any growth in income inequality.

Applying this idea to New Zealand might mean that inequality has been decreasing. Important note: "inequality", not "income inequality" (an important distinction, because we're not just talking about monetary income now).

The argument goes like this - first, our total compensation from any job includes both monetary and non-monetary components. The non-monetary characteristics of jobs include things like how annoying your work colleagues are (or how vivacious and enthusiastic, depending on your perspective), how boring or monotonous (or exciting) your job is, and how dangerous to life and limb your job is.

Think about two jobs that have the same human capital requirements. If the first job has attractive non-monetary characteristics (e.g. it is exciting) then more people will be willing to do that job. This leads the supply of labour to be higher, which leads to lower equilibrium wages. In contrast, if the second job has negative non-monetary characteristics (e.g. it comes with a high risk of death or injury) then fewer people will be willing to do that job. This leads the supply of labour to be lower, which leads to higher equilibrium wages. The difference in wages between the attractive job that lots of people want to do and the dangerous job that fewer people want to do is called a compensating differential. This is the reason why welders on oil rigs earn US$61,000-66,000, while spot welders in general earn US$24,000. Oil rig work comes with negative characteristics like lots of time away from family (for some families, this might be a positive characteristic!), and higher risk of death or injury.

Importantly, it is likely that compensating differentials have been changing over time. John McGinnis points out that in the U.S., "Since 1970 workplace deaths have plunged 65 percent and workplace illnesses 67 percent." Similarly, if we look at more recent data from New Zealand, the incidence of workplace injuries has fallen from 119 per 1,000 full-time equivalent employees in 2008, to 92 per 1,000 full-time equivalent employees in 2013.

How does that relate to inequality though? It depends. John argues that "These economic transformations differentially help those on the lower income part of the scale". Increases in inequality would be mitigated, if the improvements in non-monetary characteristics were greatest among the lowest-paid workers.

We can use some freely available data to check this. Using the injury data linked above and data from the NZ Income Survey by occupation, we can create a very crude analysis (which is made difficult by the change in occupational classifications over time). I picked three occupations that are reasonably consistently defined between the NZSCO95 classification (which is used in the injury statistics) and the NZSCO99 and ANZSCO classifications (that are used in the income statistics): (1) Professionals (median hourly wage of $30.17 was the highest of all occupations in June 2013); (2) Clerical and administrative workers ($21.58); and Machinery operators and drivers ($19.34).

For these three groups, between 2008 and 2013, injury incidence fell 19.5% for professionals, 41.9% for clerical workers, and 27.5% for machinery operators. So, injury incidence did fall by a greater proportion for the two lower-paid occupational groups when compared with professionals over this period, but it was the clerical workers who had the highest injury gains (note: they also had the highest income gains over this period, with median wages increasing by 21.7%). Perhaps there is something to this that could do with some further investigation - however, you would probably want to take into account how much people value reductions in injury incidence (since otherwise there is no easy way to combine change in wages with the change in injury incidence).

Now, why does this mean that inequality might have been decreasing in New Zealand? As Eric Cramption has pointed out on many occasions (e.g. see here or here), income inequality has been fairly static in New Zealand since the 1990s. So if income inequality has been static, but the non-monetary characteristics of occupations have changed in ways that favour occupations with lower median wages, then perhaps overall inequality has been decreasing. Of course, that assumes that there hasn't been a big shift in the occupational structure of the economy away from the lower-wage jobs (which there has - in the three occupations I used above, professionals increased from 17.3% to 19.5% of full-time equivalent employees between 2008 and 2013, and machinery operators and drivers decreased from 8.8% to 8.0%). Again, the relative effects on inequality of changes in wages, non-monetary characteristics, and changes in occupational structure of the economy, is something that bears further investigation.

[HT: Marginal Revolution]