Recent Declines in Labor’s Share of Income

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from NCPA,

Over the past decade, in addition to its poor employment performance, the U.S. economy has been plagued by sluggish wage growth and rising income inequality. The growth in real GDP per worker over the decade of the 2000s that averaged 1.7 percent annually was more rapid than in the 1970s, 1980s or 1990s, yet in the 2000s workers saw almost no increase in their take home pay or share of national income. Since the 1960s labor’s share of national income has oscillated between 64 percent and 67 percent. However, since the onset of the financial crisis that share of income has fallen below historical levels.

The counterpart to the declining labor share has been a rise in the share of capital that has been especially concentrated in corporate profits, and since claims on profits are far less equally distributed than wages, this has contributed to increased income inequality.

The natural starting point for explaining factor income shares is the neoclassical theory of the functional distribution of income. If capital and labor are substitutes, as Thomas Piketty has suggested, then a decline in labor’s share of income is explained by increased use of capital. However, as Robert Lawrence empirically shows in his study of industry and aggregate data, if they are compliments an explanation of the decrease in labor’s share of income is that there is not enough capital.

Lawrence’s empirical evidence corroborates many others in concluding that in the United States capital and labor are compliments. He also found that the cause of labor’s falling share recently is the weakness of investment in the face of faster labor-augmenting technical change. This suggests that measures that boost investment and capital formation would lead to higher wages, raise labor’s share in income, and reduce income inequality.

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