they operate through these three mechanisms, their impact is a prioir ambiguous. Our results indicate that
the factor distribution of income is still an essential component of personal income inequality, and that
the impact of labour market institutions operates in part through the way in which income is shared
between capital and labour. The overall effect of stronger institutions is to reduce income inequality, with
part of this effect occurring through wage compression and part of it through a reduction in the rewards
to capital.
Our analysis has important policy implications. The first one concerns the role of redistribution.
The view that a widening wage dispersion has been the major cause of the recent increase in income
inequality leaves little role for policy. The increase in wage dispersion is usually seen as the result of trade
and innovation. Since both increased openness and technological change are seen as desirable, greater
inequality has been perceived as an unavoidable by-product of the growth process. Income redistribution
can then be used to reduce net-income inequalities, but would not affect the distribution of market
incomes. In contrast, the negative impact of the labour share on the Gini coefficient indicates that the
distribution of wealth across agents is still a major source of inequality, and hence leaves room for policy
to affect inequality in the long-run. Income redistribution will have the effect of reducing differences in
the accumulation of wealth across agents and hence affect gross-income inequalities in the future.
The second aspect concerns the role of labour market institutions as a source of equalisation. We
have found that labour market institutions significantly affect income inequality through several channels:
stronger unions obtain a larger wage share and compress wage differentials, while higher minimum wages
reduce wage differentials. Despite the associated increase in the unemployment, the overall impact is to
reduce inequality. A caveat is, however, in order. Our analysis is static and takes the stock of physical
capital as given. This implies that we are ignoring the potential impact of labour market institutions on
investment. Given the strong equalising effect that a higher capital-labour ratio has, this is an important
question that remains to be addressed in future work.
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