The stability of the share of total income paid out as compensation to labor, or the labor share, has been a fundamental feature of macroeconomic models. This assumption carries with it a broad range of important implications for macroeconomic dynamics, growth, and income inequality. Recently, however, a significant decline has been documented in the labor share over the past 30 years in the United States and in most countries in the world. The declining labor share has been among the most important policy topics over the past several years, attracting calls for changes in government policies. The project aims to develop tools to better understand the causes and implications of the labor share decline.
Empirically, this research project aims to create novel state-industry and firm datasets of labor shares that would offer rich variation useful for identifying the cause of the labor share decline. It has been demonstrated that labor share declines were greatest in countries and industries experiencing the largest declines in the relative price of investment goods. This suggests the importance for this trend of technological progress in capital producing sectors in an environment with highly substitutable capital and labor.
These additional new datasets will help corroborate the extent to which cost of capital declines caused the decline of the U.S. labor share and to differentiate between this and alternative explanations, such as changes in monopoly power or industry composition or the influence of international trade. Differentiating among these alternatives will directly inform what types of policies, if any, may be warranted in response to the declining labor share.
Theoretically, this research project builds a framework that allows one to think about the repercussions of the labor share decline for income inequality. This research team is developing a model that incorporates a CES production structure with capital-skill complementarity into an incomplete markets model with heterogeneous agents, allowing one to understand the joint dynamics of the distribution of income across factor shares and the distribution of income across households. While various countries have generally witnessed declining labor shares and increasing income inequality during recent decades, the relationship between these trends can be quite complicated in an environment with realistic features such as endogenous savings decisions, endogenous labor supply, capital-skill complementarity, and life-cycle dynamics.
