1. Introduction
Over the past two decades a large literature has sought to understand the evolution of wage inequality in
OECD countries; see, for example, Gottschalk and Smeeding (1997). Different patterns across countries
have been documented, and labour market institutions have been shown to play an important role in
determining the distribution of wages. In this paper we try to understand which are the determinants of
differences in income inequality across countries and over time in OECD countries. In doing so, we focus
on two aspects largely neglected by the literature. The first one is the role of factor shares as determinants
of the personal distribution of income. We argue that wage inequality is only one of the components of
personal income inequality, and that both the labour share and unemployment play an important role. The
second aspect consists of understanding the impact of labour market institutions on overall income
inequality, as opposed to only on relative wages.
Contrary to the textbook approach in macroeconomics where factor shares are taken to be
constant, variations in the labour share across countries and over time are large. Figure 1 illustrates the
recent experiences of the US, the UK, Germany and France over the period 1960 to 2002. The US has the
most stable labour share, which fluctuates between 55 and 59 per cent. France and Germany have, for
most of the period, a lower labour share than the two Anglo-Saxon countries, and exhibit a hump-shaped
pattern with the labour share increasing up to around 1981 and declining thereafter; while the UK has
experienced a decline over the period.1 Despite a substantial reduction in the differences between those
four countries, in 2002 their labour shares ranged from 53% in France to 58% in the US.
The first question we address in this paper is whether these differences in the factor distribution
of income can help us explain variations in the distribution of personal incomes in OECD countries over
the past thirty years. Indeed, recent work by Piketty (2001, 2003) and Piketty and Saez (2003) has
emphasised the importance of capital income for the highest income groups even in recent times, and
Atkinson (2003) has suggested that the increase in inequality that took place in a number of OECD
countries during the 1980s was in part due to the rise in the return to capital. Our second concern is the
impact of labour market institutions. The effect of institutions on relative wages has been well
documented. For example, stronger unions tend to compress the wage distribution, which in turn would
tend to reduce income inequality. However, these institutions also affect the unemployment rate and,
potentially, the labour share, and hence will affect the distribution of income through channels other than
wages.
1 The notable exception is the sharp increase and subsequent fall of the labour share during the labour government
of 1974-1976, after a period of major conflict between unions and the conservative government of Heath.