Automation and Top Income Inequality
Abstract: For almost 40 years, top income inequality has increased sharply in the US. At the same time, there have been major improvements in automation technology. It is well-known the top income is well approximated by a Pareto distribution. In this paper, we provide a theory that links automation technology to the Pareto tail of the income distribution. We construct a model in which the span of control is defined by the measure of labor used in production. We model this as a convex cost of labor, and it generates a decreasing returns to scale production function. An improvement in automation enables entrepreneurs to substitute labor with capital and it decreases the severity of diseconomies of scale. This leads to higher returns to entrepreneurial skills, to a decrease in the Pareto parameter and to an increase in top income inequality. We rationalize the convex cost of labor using a theory of efficiency wages. Using cross-industry and cross-country data, we provide evidence that there is a significant correlation between automation and the top income inequality.
