Digital Innovation and the Distribution of Income

Income inequalities have increased in most OECD countries over the past decades, and the income share of the top 1 percent has risen. In this paper we argue that the growing importance of digital innovation—new products and processes based on software code and data—has increased market rents that benefit disproportionately the top income groups. In line with Schumpeter’s vision, digital innovation gives rise to ”winner-take-all” market structures, characterized by higher market power and risk than was the case in the previous economy of tangible products. The cause for these new market structures is digital non-rivalry, which allows for massive economies of scale and reduces costs of innovation. The latter stimulates higher rates of creative destruction, leading to higher risk as merely marginally superior products can take over the entire market, hence rendering market shares unstable. Instability commands risk premia for investors. Market rents accrue mainly to investors and top managers and less to the average employees, hence increasing income inequality.