Inequality in the Digital Era

Inequality in the Digital Era

Markets have shifted toward more monopolistic structures, giving rise to higher economic rents.

By Zia Qureshi

The digital revolution is transforming economies. Potential economic gains from digital technologies are enormous, but with new opportunities come new challenges. Within economies, income and wealth inequalities have risen as digitization has reshaped markets and the world of business and work. Inequalities have increased between firms and between workers. The distribution of both capital and labour income has become more unequal, and income has shifted from labour to capital. Technological change, however, is not the sole reason for the rising inequalities. Policy failures have been an important part of the story. Policies will need to be more responsive to the new dynamics of the digital economy to achieve outcomes that are more inclusive.

We are living in an era of mounting societal discontent and political divisiveness. In many countries, social disaffection with economic outcomes is up sharply, stoking populist and nationalist sentiment. Increasing income inequality is one important reason behind this socio-political tumult.

We are also living in an era of major technological change, led by the digital revolution. Today’s technological changes—advances in computer systems and software, mobile telephony, digital platforms, robotics, cloud computing, artificial intelligence, and cyber-physical systems—are arguably unparalleled in their scope and speed.

Are these two megatrends of our time connected? The answer is yes. 

Digital technologies are reshaping the world of business and work in profound ways. Policies have been slow in adapting to the new dynamics. The interaction between technological change and market conditions as influenced by the prevailing policy environment has been a key factor driving income inequality higher. Disruptions caused by technological change have added to business and worker anxieties.

A more unequal distribution of income, however, is not an inevitable consequence of a digitising world. Outcomes that are more inclusive are certainly possible with better, more responsive policies.

Rising inequality amid booming technologies

Income inequality has risen in practically all major advanced economies since the 1980s, a period of a rising boom in digital technologies. It has risen particularly sharply at the top end of the income distribution. Wealth inequality is still more acute, roughly twice as high as income inequality. In emerging economies, income distribution trends are more mixed but many major emerging economies also witnessed a rise in income inequality. In the two largest emerging economies, China and India, inequality has increased appreciably.

In the cauldron of political debate, much of the blame for the rise in income inequality and underlying business and job dislocations is heaped on globalisation—often from both ends of the political spectrum. The backlash against globalisation threatens a retreat into economic nationalism and inward-looking policies. Globalisation has, indeed, been a factor behind rising inequality. However, a much bigger factor has been technological change.

Not only is the proverbial economic pie being shared more unequally, it has also been growing more slowly, adding to social discontent. Paradoxically, productivity growth in major economies has slowed rather than accelerated during the boom in digital technologies. This has slowed overall economic growth. Research finds that the same interaction between technological change and policy failures that contributed to higher income inequality also explains why the new technologies have not delivered their full potential to boost productivity. Developments in income distribution and productivity have been linked by shared dynamics.

Transformations in the world of business

Digital technologies are altering business models and how firms compete and grow. They are reshaping market structures. Change affects all markets, from production and commerce to finance. The manner in which the new technologies deploy across industries and firms has important implications for their economic impact and the distribution of rewards.

The benefits of the new technologies have not diffused widely across firms. They have been captured for the most part by a relatively small number of larger firms. Productivity growth has been relatively strong in leading firms at the technological frontier. However, it has slowed considerably in the vast majority of other, typically smaller firms, pulling aggregate productivity growth lower. Between 2001 and 2013, in OECD economies, labour productivity among frontier firms rose by around 35 percent; among non-frontier firms, the increase was only around 5 percent. Aggregate labour productivity growth in OECD economies in the decade to 2015 was only about half of that in the preceding two decades. The growing inequality in productivity performance between firms not only depressed productivity growth, but also caused income disparities to rise.

With increased market power, the distribution of returns on capital has become more unequal, with a relatively small number of firms reaping supernormal profits. In the United States, for example, the ninetieth percentile firm earned a return on invested capital reaching around 100 percent in 2014, which was more than five times the return earned by the median firm; this ratio was around 2 about twenty-five years ago. The uneven distribution of returns on capital was particularly marked in technology-intensive industries. There is also evidence of low churning among high-return firms, with a large proportion of such firms persistently achieving high rates of return.

Markets have shifted toward more monopolistic structures, giving rise to higher economic rents. The share of “pure profits” or rents (profits in excess of those under competitive market conditions) in total income in the US economy rose from 3 percent in 1985 to 17 percent in 2015. As monopoly profits boosted the market value of corporate stocks and produced large capital gains, the share of total US stock market value reflecting monopoly power (“monopoly wealth”) rose from negligible levels to around 80 percent over the same period.

Why is market power rising and competition weakening? 

First, the new technologies are contributing to increased market concentration by altering competition in ways that produce “winner-takes-most” outcomes. Digital technologies offer first-mover advantages, scale economies, network effects, and leverage of “big data” that encourage the rise of dominant firms—and globalization reinforces the scale economies by facilitating access to markets worldwide. The rise of “the intangible economy,” where assets such as software and intellectual property matter more and more for economic success, has been associated with a stronger tendency toward the emergence of dominant firms. Digitization also allows firms controlling big data to extract more of the consumer surplus through increasingly sophisticated algorithmic pricing and customization of offerings.

The winner-takes-most dynamics have been most marked in the high-tech sectors, as reflected in the rise of “superstar” firms such as Facebook and Google. Increasingly, however, they are affecting economies more broadly as digitization penetrates business processes in other sectors, such as transportation, communications, finance, and commerce. In retail trade, for example, the big box stores, which previously had replaced mom and pop outlets, are now
losing market share to online megastores such as Amazon.

Second, failures in competition policies have reinforced the technology-driven dynamics producing more concentrated market structures. These include weaknesses in antitrust policies, flaws in patent systems that act as barriers to a wider diffusion of innovations, and regulatory acts of omission and commission (deregulation unsupported by competition safeguards, and regulations that restrict competition). Related factors include an increase in overlapping ownership of companies that compete by large institutional investors, rise in rent seeking, and firm behaviour showing greater adeptness in erecting barriers to entry through product differentiation and other means.

Financialization

Digital technologies have been instrumental in the financialization of economies, reinforcing the impetus from financial sector deregulation. Generally, credit and other financial intermediation has grown three times as fast as economic activity in recent decades. The rapid financialization compounded the inefficient and unequal outcomes resulting from decreased competition in markets. In the credit boom that preceded the global financial crisis, the lion’s share of the credit went to households rather than firms, boosting stock and real estate markets rather than productive investment—an allocation of credit with negative implications for growth, stability, and income distribution. There has been much innovation in financial services based on the new technologies. A large part of it, however, has been focused on areas such as trading and asset management that primarily benefit the well-off and do not have first-order effects on economic productivity.

Rewards in the financial sector rose sharply relative to the real economy. In the United States, the financial sector captured an outsize share of profits—35–40 percent of all corporate profit in the years leading to the financial crisis. A sizable part of these high profits reflected rents in an increasingly concentrated sector: the top five banks’ share of banking assets increased from 25 percent in 2000 to 45 percent in 2014. In European countries, financial sector workers on average accounted for one in five of the top 1 percent of earners even though they accounted for only one in twenty-five of the total workforce. Financial wealth boomed but benefited mainly those at the top; in the United States, the top 1 percent of the wealth distribution held half of stock and mutual fund assets in 2013, and the top 10 percent held more than 90 percent.

Transformations in the world of work

Just as transformations in the world of business caused by digitization-driven technological change have been a key factor influencing the distribution of capital income, technology-driven transformations in the world of work have been a key factor influencing the distribution of labour income.

Rent sharing also contributed to wider wage differences between firms. Better-performing firms reaped a higher share of total profits and shared part of their supernormal profits with their workers. Increased fissuring of the workplace through outsourcing played a role as well, with noncore activities typically employing low-skill workers farmed out to other firms, cutting such workers from the rent sharing. Between-firm wage inequality rose more in industries that invest more intensively in digital technologies. Overall, wage inequality has risen sharply in the past couple of decades and much of that rise is attributable to increased wage differences between firms.

There has been much innovation in financial services based on the new technologies, but much of it has focused on areas such as trading and asset management that primarily benefit the well-off

Increased market concentration has played a role in the shifting of income from labour to capital as it reallocated labour within industries to dominant firms with supernormal profits and lower labour-income shares. Dominant firms not only acquired more monopoly power in product markets to increase mark-ups and extract higher rents but also monopsony power to dictate wages in the labour market. A new phenomenon has been the fast-expanding digital labour markets—online jobs platforms such as Task Rabbit and Amazon Mechanical Turk. 

International trade and offshoring also contributed to the shift in income toward capital by putting downward pressure on wages, especially of lower-skilled workers in tradable sectors. Overall, research shows that globalization has played a significant role in the decline of the labour-income share. However, it also shows that globalization’s role has been much smaller than that of technological change and related outcomes. IMF research finds that, in advanced economies, technological change has contributed about twice as much as globalization to the decline in the labour-income share.

Job polarization and skills mismatches

Technology has been the dominant force in reshaping the demand for labour. Digital technologies and automation have shifted demand toward higher-level skills. Globalization has exerted pressure in the same direction. Demand has shifted, in particular, away from routine, middle-level skills that are more vulnerable to automation, as in jobs like clerical work and repetitive production. Job markets have seen an increasing polarization, with the employment share of middle-skill jobs falling and that of higher-skill jobs, such as technical professionals and managers, rising. The employment share of low-skill jobs has also increased but mainly in nonroutine manual jobs in services such as personal care that are hard to automate. Between 1995 and 2015, the share of middle-skill jobs in total employment fell by about 9.5 percentage points in OECD economies on average, while the shares of high-skill and low-skill jobs rose by about 7.5 and 2 percentage points, respectively. A concurrent development has been the rise of the “gig” economy, with more workers engaged in nonstandard work arrangements, such as temporary or part-time contracts and own-account employment.

As the demand for skills has shifted, supply has been slow to adapt. Education and training have been losing the race with technology. Shortages of higher-level skills demanded by the new technologies have prevented a broader diffusion of the innovations across firms. Workers with skills complementary with the new technologies have been clustered increasingly in leading firms at the technological frontier. Across industries, skills mismatches have increased: on average around one-quarter of workers report a mismatch between their skills and those required by the job.

As technological change interacted with developments in product, financial, and labour markets to drive income inequality higher, making the distribution of both capital and labour income more unequal and shifting income from labour to capital, the state’s role in alleviating the inequality of market incomes arising from the interplay of these forces weakened. In advanced economies, taxes and transfers reduce market income inequality on average by about one-third: in 2015, the average Gini Index for disposable income in these economies was 0.31 compared with 0.48 for market income. Between 1985 and 1995, fiscal redistribution offset about 60 percent of the increase in market income inequality in advanced economies. Between 1995 and 2010, it hardly offset any.

Inclusive growth

The rise of the digital economy has pushed income inequality higher. At the same time, the potential of the new technologies to spur productivity growth has not been fully realised. However, this should not provoke despair, much less a negative backlash.

Most dynamic economic change is inherently disruptive, creates winners and losers, and entails difficult transitions. Technology—and globalization—are no exceptions. They are key forces that drive economic progress. Advances in digital technologies hold great promise to boost productivity and economic growth, create new and better jobs to replace old ones, and enhance human welfare. Policies have a crucial role to play in ensuring that the potential gains are captured effectively and inclusively—by improving the enabling environment for firms and workers to broaden access to the new opportunities that come with change and to enhance capabilities to adjust to the new challenges. Unfortunately, policies and institutions have been slow to rise to the new challenges of the digital economy. Indeed, they have often exacerbated rather than ameliorated the outcomes.

Policies to reduce inequality are often seen narrowly in terms of redistribution—tax and transfer policies. However, there is a much broader policy agenda of “predistribution” that can make the growth process itself more inclusive. Much of the reform agenda to achieve more inclusive outcomes from technological change is also an agenda to achieve stronger growth outcomes, given the linked dynamics between the recent rise in inequality and the slowdown in productivity.

Revitalising competition for the digital age

Competition policies should be revamped for the digital age to ensure that markets continue to provide an open and level playing field for firms, keep competition strong, and check the growth of monopolistic structures. This includes regulatory reforms and stronger antitrust enforcement. The winner-takes-most dynamics associated with digital technologies is raising new challenges for competition policies, including how to address market concentration resulting from tech giants that resemble natural or quasi-natural monopolies. Once in dominant positions, firms can entrench themselves by erecting a variety of barriers to entry and taking over rising competitors. The beneficiaries of an open, competitive system often work to close the system and stifle competition, necessitating reform to “save capitalism from the capitalists” (Rajan and Zingales, 2003; Krugman, 2015). Competition policy also needs to become more global to address cross-border issues posed by multinational tech giants that affect market concentration and competition in many countries.

Proprietary agglomeration of data, as in digital platforms, is an increasingly important source of competitive advantage. Regulations pertaining to digital platforms, ownership of data, how user data are handled, and privacy protections matter increasingly for competition. There has been more action on this agenda in Europe than in the United States, an example being the General Data Protection Regulation (GDPR) introduced in Europe in 2018.

Enhancing competition is also important in financial markets, to address issues such as increased concentration, interconnectedness, and rent seeking. It would spur better use of advances in digital technology to expand the range of financial services and reduce their cost, open new gateways to entrepreneurship, and democratize access to finance. Innovations such as mobile financial services, digital platforms, equity crowdfunding, and blockchains have much potential. Young FinTech firms are in the vanguard in the application of such innovations. A challenge for policy-makers is to foster the growth of these new entrants into the financial industry while managing associated risks.

IMF research finds that, in advanced economies, technological change has contributed about twice as much as globalization to the decline in the labour-income share

Skills for a changing world of work

Advances in digitization, robotics, and artificial intelligence have led some to draw up dire scenarios of massive job losses from automation (a “robocalypse”). However, experience with past major episodes of automation shows that as technological change made some old jobs redundant, it generated new ones by creating new roles and tasks and spurring economic growth. How technological change impacts employment must be seen as a dynamic adjustment process of old jobs giving way to new ones. Looking ahead, not only will the skill needs of jobs continue to evolve, but the composition of employment will evolve as well, with more people working independently—including as microentrepreneurs in an expanding “crowd-based capitalism” enabled by digital platforms, as exemplified by Uber and Airbnb.

Many breakthrough innovations developed commercially by private firms originate from government-supported research. Recent examples include Google’s basic search algorithm, key features of Apple smartphones, and even the Internet itself

The main issue is that the nature of work is changing, and the main policy challenge is to equip workers with nonroutine, creative, and higher-level skills that the new technologies demand and to support workers during the adjustment process. Traditional formal education must be complemented with new models and options for reskilling and lifelong learning. As the old career path of “learn-work-retire” gives way to one of continuous learning—a process reinforced by the aging of many economies’ workforces—the availability and quality of continuing education must be scaled up. This will demand innovations in the content, delivery, and financing of training, including new models of public-private partnership. It will involve experimentation, and learning from what works, such as the apprenticeship system in Germany. The potential of technology-enabled solutions, such as online learning platforms, must be harnessed, supported by a stronger foundation of digital literacy.

A strong commitment to improving access to affordable and quality education, including skills upgrading and retraining, for the economically disadvantaged is also vital. Even in an advanced economy such as the United States, almost two-thirds of workers do not have a college degree. Gaps in higher education attainment by family income level have widened rather than narrowed.

Revamp labour market policies and social protection

Labour market policies and social protection arrangements must be reformed to improve workers’ ability to change jobs. This means shifting the focus from backward-looking policies, such as the stringent job protection laws in many European economies that seek to keep workers in existing jobs, to forward-looking policies that encourage reemployment, including innovative unemployment/wage insurance mechanisms, retraining, and placement services.

Other barriers to worker mobility and competition in labour markets, such as the ever-increasing professional licensing requirements and noncompete covenants in worker contracts, should also be addressed. Well-functioning labour market institutions—collective bargaining, minimum wage laws, labour standards—are important to ensure that workers get a fair share of economic returns, especially at a time of rising market power of dominant firms.

Social contracts will need to be overhauled. Benefits such as pension and health care, traditionally based on formal long-term employer-employee relationships, need to be made more portable and adapted to evolving work arrangements, including the expanding gig economy. Here, several proposals have been put forward, including a universal basic income currently being piloted in some jurisdictions, a negative income tax up to a certain income threshold, and social security accounts that pool workers’ benefits and are portable across jobs. Reform options will need to be considered in a context where many social security systems already face financial sustainability challenges.

Pursuing labour market and social protection reforms as a package will have the advantage of capturing reform synergies and easing the adjustment for workers. For example, in 2017, France implemented reforms to its job protection laws to boost labour market flexibility combined with the introduction of a portable “personal activity account” that enables workers to accrue rights to training across multiple jobs.

The wealth dynamics of recent decades paint a picture of private riches and public poverty. While private wealth has soared, public wealth has declined, hobbling the capacity of public policy

Reform tax systems

Tax policy is often seen as presenting trade-offs between efficiency and growth on the one hand and equity on the other. Trade-offs do exist, but there are win-win opportunities for reform. In labour-income taxation, reducing the tax wedge for low-wage workers through greater use of options such as earned-income tax credit can boost labour force participation as well as improve distributional outcomes. Countries may consider shifting part of the financing of social benefits to general tax revenue to avoid overburdening social security contributions and labour-income taxation. Such a shift in financing may also be needed to extend social security coverage to those working independently or in short-term or other atypical contracts. The changing nature of work will require more attention to horizontal equity in taxes and transfers for workers in different types of work arrangements.

Making better use of wealth taxes can improve both the efficiency and equity of tax systems. Wealth taxes are underutilized and have not kept pace with the surge in wealth. High wealth inequality is a key driver of intergenerational persistence of income inequality. The proposal to find a better way to tax wealth certainly has merit. The wealth dynamics of recent decades paint a picture of private riches and public poverty. While private wealth has soared, public wealth has declined, hobbling the capacity of public policy.

There is scope to recover some of the lost tax progressivity without hampering economic growth. Higher progressivity does not necessarily mean sharply raising marginal tax rates. A more efficient way is to reform the assortment of regressive and distortive tax expenditures that characterize most tax systems—and curb tax evasion.

Conclusion

Digital technologies are transforming the world of business and work. A key challenge for policies is to harness the potential of these technologies to produce more robust and inclusive economic growth. Policies will need to be more responsive to change, which will only intensify as advances in artificial intelligence and other innovations take the digital revolution to another level. New thinking and policy adaptations will be needed in areas such as competition policies, innovation systems and knowledge diffusion, infrastructure underpinning the digital economy, upskilling and reskilling of workers, social protection regimes, and tax policies. The era of smart machines will demand smarter policies.  (

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