Shifting Tastes Advancing Technologies: A New Perspective on Income Inequality

In this paper, I examine how changing consumer demand affects income inequality in the context of technological change in the US. I develop a general equilibrium structural transformation model that incorporates time-varying demand shifters –Temporal Demand Growth Factors (TGFs). The estimates of TGFs reveal significant heterogeneity in demand patterns across goods and households. Counterfactual analysis shows that TGF-driven demand effects substantially moderate the rise in income inequality due to technological change. In the absence of these demand effects, the increase in income inequality between 1989 and 2021 is 73% larger. Changes in demand particularly benefit workers in less productive and more labour intensive non-routine manual and routine cognitive sectors, consistent with Baumol’s cost disease. The reallocation of economic activity towards sectors with lower productivity growth, driven by changes in demand, is associated with more equitable income distribution, suggesting that demand driven slowdown in productivity growth is not necessarily detrimental to our economic wellbeing.