Greater Unionization Not the Solution to Income Inequality

Income inequality is the most important problem facing America today, but in order to create sustainable solutions we first need to understand the root causes. The debate is not personal, as some populist politicians make it out to be, but simply a matter of policy. Recently there have been calls for a return to greater unionization, which is most certainly not the answer. The ultimate goal is to improve quality of life for all Americans, and to do that, growing the pie is just as important as restoring labor’s slice.

From 1940 to 1980, labor’s share of national income hovered around 65% while a fast-growing pie led to dramatically improved living standards. But since 1980 labor’s share has steadily declined to around 60% while the overall economic pie has started to grow more slowly – a combination has led to worsening living conditions for the lower- and middle-classes.

While there is a correlation between the decline in union membership and the downturn in labor’s share of the pie, causation is a stretch. Several factors have contributed to the shift:

1. Demographics. Baby boomers are living and working longer than expected because of advancements in healthcare, keeping the bargaining power in the labor force skewed in favor of capital.
2. Automation. When deciding between automation and hiring, companies today automate with an elasticity of around 1.3, tipping the balance of power further toward capital.
3. China. The beginning of labor’s decline around 1980 coincides with the rise of Chinese economy and outsourcing of unskilled labor. The problem is not China’s rise, but rather its brazen violations of free and fair trade agreements. According to free trade theory, the Chinese Yuan should have tripled from 1990 to 2013, but instead lost half its value. Unfair Chinese trade practices create distortions and grow corporate profits at the expense of American labor. 
4. Rapid earnings growth. Earnings have grown well beyond the historical norm in recent years due largely to accommodative central bank monetary policy, which allows companies to shore up balance sheets and perform share buybacks, but has less incremental benefit for labor.
5. Less unionization. While unions do increase labor’s bargaining power, they create distortions and shrink the economic pie because they are uncompetitive.
6. Skills mismatch. Demand for skilled labor has grown considerably while there has been deterioration in the quality of the US education system.
7. Poor policy. The lack of fiscal stimulus during a period of zero interest rates is the greatest missed opportunity of our generation. Legislators have squabbled over personal income tax levels when the focus should have been on corporate tax structure. Obamacare has then exacerbated labor issues by creating incentives for part-time hiring in lieu of full-time employment.

There are ways the labor/capital balance could naturally correct itself: 1) companies begin to increase entry-level salaries for competitive reasons (which we have started to see), 2) rising interest rates make labor more attractive relative to capital (reversing a 30-year trend) and create a mean reversion in corporate profits, 3) stronger currencies and wage growth in emerging markets alleviate the pressure of a strong dollar on the US labor force, 4) demographic shifts restore labor’s bargaining power with management.

However, this issue is too important to leave to chance. We can super-charge the recovery by undertaking measures to grow the pie and labor’s share of it.

1. Infrastructure spending. Put millions of people and cheap capital to work rebuilding American transportation and energy infrastructure. The money will multiply in our economy and leave the country better off for our children.
2. Crackdown on currency manipulation. China is slowly allowing the Yuan to float, but not to equilibrium. In fact, we need to confront China on a number of fronts, and hopefully our recent strategic alliance with India is evidence we are growing a stronger backbone. 
3. Education reform. We need to push more middle- and high-school aged kids to gain technical skills. In Germany, for example, almost half of high school students have technical apprenticeships, while that number in the US is 0.025%. We need to properly educate our workforce to fill the skilled jobs demanded in our increasingly technological society.
4. Tax reform. Dramatically lower corporate tax rates, which would spur hiring, domestic business activity and tax revenue.

While it’s clear America needs to address its growing divide, greater unionization is not the answer. Our political leaders disagree on many things, but they must find common ground to adopt pro-growth, free market-based policies to stimulate our economy. Anything less is malpractice.