Why Workers Are Losing the War Against Machines

2. Superstars vs. Everyone Else

The second division is between superstars and everyone else. Many industries are winner-take-all or winner-take-most competitions, in which a few individuals get the lion's share of the rewards. Think of pop music, professional athletics, and the market for CEOs. Digital technologies increase the size and scope of these markets. These technologies replicate not only information goods but increasingly business processes as well. As a result, the talents, insights, or decisions of a single person can now dominate a national or even global market. Meanwhile good, but not great, local competitors are increasingly crowded out of their markets. The superstars in each field can now earn much larger rewards than they did in earlier decades.

The effects are evident at the top of the income distribution. The top 10% of the wage distribution has done much better than the rest of the labor force, but even within this group there has been growing inequality. Income has grown faster for the top 1% than the rest of the top decile. In turn, the top 0.1% and top 0.01% have seen their income grow even faster. This is not run-of-the-mill skill-biased technical change but rather reflects the unique rewards of superstardom. Sherwin Rosen, himself a superstar economist, laid out the economics of superstars in a seminal 1981 article. In many markets, consumers are willing to pay a premium for the very best. If technology exists for a single seller to cheaply replicate his or her services, then the top-quality provider can capture most--or all--of the market. The next-best provider might be almost as good yet get only a tiny fraction of the revenue.

Technology can convert an ordinary market into one that is characterized by superstars. Before the era of recorded music, the very best singer might have filled a large concert hall but at most would only be able to reach thousands of listeners over the course of a year. Each city might have its own local stars, with a few top performers touring nationally, but even the best singer in the nation could reach only a relatively small fraction of the potential listening audience. Once music could be recorded and distributed at a very low marginal cost, however, a small number of top performers could capture the majority of revenues in every market, from classical music's Yo-Yo Ma to pop's Lady Gaga.

Economists Robert Frank and Philip Cook documented how winner-take-all markets have proliferated as technology transformed not only recorded music but also software, drama, sports, and every other industry that can be transmitted as digital bits. This trend has accelerated as more of the economy is based on software, either implicitly or explicitly. As we discussed in our 2008 Harvard Business Review article, digital technologies make it possible to replicate not only bits but also processes. For instance, companies like CVS have embedded processes like prescription drug ordering into their enterprise information systems. Each time CVS makes an improvement, it is propagated across 4,000 stores nationwide, amplifying its value. As a result, the reach and impact of an executive decision, like how to organize a process, is correspondingly larger.

In fact, the ratio of CEO pay to average worker pay has increased from 70 in 1990 to 300 in 2005, and much of this growth is linked to the greater use of IT, according to recent research that Erik did with his student Heekyung Kim. They found that increases in the compensation of other top executives followed a similar, if less extreme, pattern. Aided by digital technologies, entrepreneurs, CEOs, entertainment stars, and financial executives have been able to leverage their talents across global markets and capture reward that would have been unimaginable in earlier times.

To be sure, technology is not the only factor that affects incomes. Political factors, globalization, changes in asset prices, and, in the case of CEOs and financial executives, corporate governance also plays a role. In particular, the financial services sector has grown dramatically as a share of GDP and even more as a share of profits and compensation, especially at the top of the income distribution. While efficient finance is essential to a modern economy, it appears that a significant share of returns to large human and technological investments in the past decade, such as those in sophisticated computerized program trading, were from rent redistribution rather than genuine wealth creation. Other countries, with different institutions and also slower adoption of IT, have seen less extreme changes in inequality. But the overall changes in the United States have been substantial. According to economist Emmanuel Saez, the top 1% of U.S. households got 65% of all the growth in the economy since 2002. In fact, Saez reports that the top 0.01% of households in the United States--that is, the 14,588 families with income above $11,477,000--saw their share of national income double from 3% to 6% between 1995 and 2007.

3. Capital vs. Labor

The third division is between capital and labor. Most types of production require both machinery and human labor. According to bargaining theory, the wealth they generate is divided according to relative bargaining power, which in turn typically reflects the contribution of each input. If the technology decreases the relative importance of human labor in a particular production process, the owners of capital equipment will be able to capture a bigger share of income from the goods and services produced. To be sure, capital owners are also humans--so it's not like the wealth disappears from society--but capital owners are typically a very different and smaller group than the ones doing most of the labor, so the distribution of income will be affected.

In particular, if technology replaces labor, you might expect that the shares of income earned by equipment owners would rise relative to laborers--the classic bargaining battle between capital and labor. This has been happening increasingly in recent years. As noted by Kathleen Madigan, since the recession ended, real spending on equipment and software has soared by 26% while payrolls have remained essentially flat.

Furthermore, there is growing evidence that capital has captured a growing share of GDP in recent years. As shown in Figure 3.6, corporate profits have easily surpassed their pre-recession levels.

According to the recently updated data from the U.S. Commerce Department, recent corporate profits accounted for 23.8% of total domestic corporate income, a record high share that is more than 1 full percentage point above the previous record. Similarly, corporate profits as a share of GDP are at 50-year highs. Meanwhile, compensation to labor in all forms, including wages and benefits, is at a 50-year low. Capital is getting a bigger share of the pie, relative to labor.

The recession exacerbated this trend, but it's part of long-term change in the economy. As noted by economists Susan Fleck, John Glaser, and Shawn Sprague, the trend line for labor's share of GDP was essentially flat between 1974 and 1983 but has been falling since then. When one thinks about the workers in places like Foxconn's factory being replaced by labor-saving robots, it's easy to imagine a technology-driven story for why the relative shares of income might be changing.

It's important to note that the "labor" share in the Bureau of Labor Statistics' data includes wages paid to CEOs, finance professionals, professional athletes, and other "superstars" discussed above. In this sense, the declining labor share understates how badly the median worker has fared. It may also understate the division of income between capital and labor, insofar as CEOs and other top executives may have bargaining power to capture some of the "capital's share" that would otherwise accrue to owners of common stock.

This is the third part of our three-part excerpt from Erik Brynjolfsson and Andrew McAfee's Race Against the Machines (Digital Frontier Press). Read Part 1 here. Read Part 2 here.

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