Great Compression

The Great Compression is the term for the sharp narrowing of wage and income differences in the United States during the 1940s, which left the country far more equal than it had been in the 1920s and kept it that way until roughly the 1970s. Pay gaps between skilled and unskilled workers, between college and high-school graduates, and between the top earners and everyone else all shrank within a few years.

The name comes from a 1992 paper by economic historians Claudia Goldin and Robert Margo, "The Great Compression: The Wage Structure in the United States at Mid-Century." Goldin later received the 2023 economics Nobel for work on women's labour-market outcomes. The idea is central to debates about economic inequality, since the reversal after 1980 is often called the "Great Divergence."

Picture a factory where, in 1939, the managers earn many times what the floor workers earn. Then a war arrives. The government freezes most pay, but lets the lowest wages rise; the factory is desperate for workers and hires anyone it can; a union signs up most of the staff; and the top earners face very high tax rates. By 1950 the gap between the top and bottom of the factory has shrunk a great deal.

The surprising part is what happened next. When the war ended and the controls were lifted, the gap did not spring back. For about thirty years pay stayed much more evenly spread, before widening again from the late 1970s.

Goldin and Margo used census data to show that the wage structure compressed sharply between 1940 and 1950. One common way of measuring this kind of spread is a percentile ratio:

• $R_{90/10}$ is the 90/10 wage ratio.
• $W_{90}$ is the wage at the 90th percentile, above which only a tenth of workers earn.
• $W_{10}$ is the wage at the 10th percentile.

If the 90th-percentile worker earns $60 an hour and the 10th-percentile worker $15, the ratio is 4; if the bottom wage rises to $20 with the top unchanged, it falls to 3, a compression. Studies of tax records by Thomas Piketty and Emmanuel Saez tell a similar story for incomes: the share of US income going to the top tenth of households fell sharply during the early 1940s and stayed lower for decades. Broader measures such as the Gini coefficient show the same pattern, and comparable compressions occurred in Britain, France, Japan and other countries around the world wars.

Economists point to several forces, and they disagree over their weights:

• Wartime wage controls. From 1942 the National War Labor Board had to approve pay rises and tended to allow larger increases for the lowest paid.
• Strong demand for less-skilled labour. War production and the post-war boom kept unemployment low and raised wages for factory work.
• More educated workers. The spread of high-school education raised the supply of educated workers, narrowing their pay premium; Goldin and Lawrence Katz later framed this as a "race between education and technology."
• Unions.Trade union membership grew rapidly from the mid-1930s, and collective bargaining tended to compress pay within firms.
• Taxes and norms. Top federal marginal tax rates reached 94% in 1944–1945 and stayed very high for years, as part of a strongly progressive tax system, and social norms around executive pay became more restrained.

A puzzle is why the compression persisted after wage controls ended in the late 1940s. Explanations include strong union bargaining, rising human capital among younger workers, the minimum wage and lasting social norms. From the late 1970s and 1980s, inequality widened again. Economists debate the reasons: skill-biased technological change that favoured educated workers, globalization and trade competition, falling union membership, lower top tax rates and changes in corporate governance all feature in different accounts. Some economists argue that the compression rested on unusual wartime conditions that could not be sustained, while others see it as evidence that institutions and policy choices, not only markets, shape the distribution of income.

The Great Compression is often cited by those who favour higher top taxes, stronger unions or a wealth tax, as proof that a large economy can grow fast while becoming more equal; the US economy did expand strongly in the 1950s and 1960s. Critics reply that post-war growth had other causes, such as rebuilding after the war, catch-up in technology and limited foreign competition, and that the policies of the period also carried costs. The episode sits alongside the Great Depression and the Great Moderation as one of the defining eras that economists use to test theories about growth and distribution.

• National Bureau of Economic Research: Goldin and Margo, "The Great Compression" (Working Paper 3817)