In an effort to provide a comprehensive, well-founded explanation to policymakers and other interested parties, the McKinsey Global Institute and McKinsey Social Sector Office have conducted a study of changes in income dispersion and their causes from 1991 to 2005, the height of the economic cycle. The study analyzed a broader, deeper data set than previous research in the area, making it the first attempt to estimate the contribution to rising dispersion of fundamental changes in the U.S. economy’s mix of industries and occupations. Its findings show that redeveloping America’s human capital should be the focus of labor market policy coming out of the recession.

Understanding the patchwork of the United States’ labor market is key to understanding what has happened to income growth. Labor income largely accounts for 75 to 85 percent of household pretax income across the income distribution, and the analysis shows that differential rates of growth in labor incomes were the most significant sources of the differential rates of household income growth across the income distribution. For this reason, the research takes as its starting point the labor market rather than household incomes as most previous studies have done, resulting in a more detailed picture than was previously available.

The report examines eight clusters of industry/occupation pairs or jobs in which employees experienced similar income levels, income growth, and employment growth over the period. The analysis reveals that 71 percent of  U.S. workers are in jobs for which there has been a decrease in demand from employers, an increase in supply of eligible workers, or both. 

The research also analyzes nine possible drivers of changes in labor income. Incomes and employment for the top-earning 22 percent of workers grew fast, mostly because new technologies and new opportunities in global markets ramped up demand for advanced skills.

Education has played a critical role in giving workers access to higher-earning job clusters. Moreover, an undersupply of workers with the skills to fill the kinds of jobs fostered by new technologies in more complex organizations means that people with those skills have been able to win income premiums. Having the appropriate education or training is the ticket to higher-paid work.

The analysis showed that migration and deunionization depressed levels of compensation for labor in repetitive manual jobs and administrative support in the four lowest-earning clusters across all industries.

At a deeper structural level, global economic integration and technological advances have combined to produce permanent changes in the skill levels required to flourish in the U.S. labor market, the research concludes. Unless the mass of America’s human capital can be developed fast, the nation risks another period in which growth resumes but income dispersion persists, with Americans in the bottom and middle-earning income clusters never really benefiting from the recovery.

While there is no single cause or “silver bullet” remedy for rising income dispersion, upgrading the productivity, skills, and rewards in the service sector is the key challenge.