Why The Gap Isn't So Giant In Europe And Japan

The same economic forces that are driving a wedge between America's rich and poor have swept across every industrialized country. But according to dozens of recent studies, inequality has remained in check everywhere except in the U.S. and Britain. Here's why: European policies such as high minimum wages and countrywide (rather than company-level) collective bargaining offset market trends that would otherwise push high-skilled workers' wages up and keep those of the lower-skilled down.

"You can overcome the market forces that have driven up inequality, but you need government intervention to do it," says Harvard University economist Richard B. Freeman. He has edited a new book, Working Under Different Rules, which summarizes 54 studies that came to this conclusion by comparing U.S. and European labor markets. The catch is that government meddling may have priced some low-wage jobs out of the market and hurt Europe's employment growth. Still, the new studies find that the damage isn't as severe as many Europeans--and U.S. economists--fear.

There is little question that inequality has remained subdued in most industrialized countries. A study of U.S. men by Rand Corp. economist Lynn A. Karoly found that those in the top 10% pay bracket earned 5.6 times as much per hour in 1992 as did men in the bottom 10%--a 17% increase in this ratio since 1980 (chart). The gap widened by 36% for men in Britain, which has removed many government-intervention policies. Even so, top earners there still make only 3.4 times more than those on the bottom. By contrast, highly paid French and German men earn only three times as much as the lowest-paid, a ratio that didn't change in the 1980s. And inequality only edged up in Australia, Canada, Japan, and Sweden, according to Freeman's book.

These countries offset market forces in various ways. France's higher minimum wages cover 12% of workers, vs. less than 5% in the U.S. And unlike in the U.S., they rise with inflation. In Austria, groups of unions and employers negotiate national wage settlements that cover most workers. And in Japan, unions ensure that low-skilled workers keep pace in national bargaining. Europe also has more government-mandated protections, such as more generous unemployment, welfare, and child-care payments, which help low-wage workers keep a job or keep afloat.

ADJUSTMENTS. Corporate America has long resisted such measures as too costly. Many economists also argue that they would force companies to hold down hiring--impeding the rapid job growth the U.S. has enjoyed since 1980. Indeed, some European leaders now blame their high unemployment on these policies. Most studies on international inequality agree--but only partly. France's minimum wages probably do contribute to double-digit youth unemployment, although to what extent is unclear, Freeman says. And Europe's generous welfare and unemployment benefits may ratchet up joblessness by giving some people an incentive not to work.

Still, European countries adjust in ways that hold down job losses, the studies find. For instance, French and German job-security laws prompt companies to reduce employee work hours before proceeding to pay cuts and layoffs--although the current recession has triggered many furloughs. Extensive worker-training systems in Germany and Japan also offset inefficiencies caused by government intervention by helping less-educated workers become better substitutes for higher-skilled ones. And many European social programs push people to work by placing time limits on welfare or providing day care for single mothers--similar to President Clinton's ideas for welfare reform. The bottom line on Europe's strategies for fighting inequality is that "in general, the programs do not have major efficiency costs," concludes Freeman.

Of course, the U.S. can't simply copy what other countries do. But Freeman and others argue that it can adapt many European methods to the American context. There's no sign, however, that this is likely to happen anytime soon.

    Before it's here, it's on the Bloomberg Terminal.