The Urgency of Returning to Full Employment: Recessions have contributed to long-run rise in inequality; undoing this one’s effects will be hard

By Greg Ip of The WSJ. Excerpt:

"We now know the business cycle’s influences aren’t purely cyclical: In the labor market, they cast a long shadow, as a new study convincingly shows.

The study looks at earnings of prime-aged men (those 25 to 54 years old) since the early 1970s and finds two distinct trends: a steady rise at the top relative to the median, and a saw-toothed decline at the bottom, with all of the decline occurring around recessions.

Authors Jonathan Heathcote and Fabrizio Perri of the Federal Reserve Bank of Minneapolis and Giovanni Violante of Princeton University agree with the consensus that inequality mainly reflects the long-run rise in the premium paid to high-skilled workers as technology, automation and foreign competition encroach on low-skilled work. But they find those forces would have been far less potent without recessions.

A worker’s wages reflect both his own abilities and education plus training and experience acquired on the job. Low-skilled men whose wages have been squeezed by the shift to high-skilled work can still get ahead by gaining experience on the job. But when they lose their job in a recession, these men face a double-whammy: The shift to high-skilled work continues, while they miss out on the chance to learn new skills on the job. After a while, many simply drop out of the labor force altogether.

Wages do suffer in a recession, but they typically recover over the course of the expansion. Not so the decline in employment. Back in 1967 just 2.5% of prime-aged men weren’t working. By 2011 that had topped 14%.

Inequality would likely have increased even without recessions. Those at the top have continued to pull away from the middle. Racial disparities and other institutional obstacles would still exist. But the gap between those at the bottom and the middle may not have widened nearly as much. The study found that the expansions from 1991 to 2001 and from 2009 to 2020 lasted long enough to reverse all of the relative decline in incomes of the bottom 20%."