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The Non-decline of the Labor Share

By Julius Probst

Following a recent piece on inequality, I will discuss a somewhat technical and very contentious topic in this blog post, that is also related to inequality: The decline or non-decline of the labor share of income.

I should probably mention as a disclaimer that I have a stake in this discussion since two chapters of my PhD thesis were devoted to this discussion :D.  

Is the labor share declining, or not?

The labor share is the part of GDP made up of employee compensation, whereas the remaining part of GDP is capital income (and imputations, more on that later).

Most people earn their living with labor income (wages) while capital income is relatively negligible for the bottom 90% in the wealth distribution.

The common narrative in recent years has been that labor is decreasing internationally, which would be a rather bad thing from an inequality point of view since capital owners tend to be wealthier. Another trend favoring the wealthy rather than the workers.

However, as I will show below, things might not be as simple as all that, they seldom are.

Focusing mostly on the US economy, the data suggests that the common narrative of a falling labor share is somewhat misleading and I arrive at a different conclusion: More specifically, the capital share has not been gaining as much in recent decades as many have claimed. Let’s have a look.

At first glance, things actually do look quite bad. The BLS data shows that employee compensation has fallen from an average of over 62% between 1950 and 1975, to 61% between 1976 and 2002 to an all-time low of 57% post 2002. 

Similarly, financialization in emerging markets has contributed to their growth trajectory in recent decades. The flipside of that coin though is that financial deregulation has also coincided with several financial crises that have occurred since the collapse of Bretton Woods in the early 1970s.

The chart below shows the total size of the global bond market, meaning both public and private debt securities. Emerging markets’ share has increased significantly over the last 3 decades, as they have also increased their global share of Global GDP.

While the US bond market is still about 1/3 of the global market, this is down from about 50% just 25 years ago.

Be aware, though, that there may be large measurement errors involved and that the labor share figures can therefore vary by source (note that the labor share was simply assumed to be constant for some countries in the beginning, which tells you something about the quality of historical macro data).

For long-run data on wage share series going back to the late 19th century, you can consult the Bengtsson-Waldenström historical factor share database.

 

What about factorless incomes

A decline in the labor share does not by default imply an increase in the capital share, since GDP also includes “factorless” income streams. These factorless incomes are economy-wide depreciation (capital consumption allowance) as well as imputed rent (the rent a homeowner would pay to himself), for example, which are not an income stream to any factor of production. These imputations matter because they are a significant share of GDP that have substantially increased in recent years.

 

Depreciation rates are rising

Depreciation is included in GDP calculations because it is a cost of production. Imputed rents are included so as not to distort GDP figures internationally since home ownership rates can differ widely.

As one can see below, depreciation rates have been rising since the 1960s by several percentage points, which in my opinion is one of the more underappreciated macro trends.

The chart below shows depreciation for the US economy, which increased from about 12% in the 1960s to about 16% in the early 2000s.

The fact that depreciation rates have increased to such an extent is certainly bad news and a topic that macroeconomists should investigate further. Digging deeper into the data, it certainly looks like almost the entire increase in depreciation of private fixed assets (leaving aside the governmental sector) comes from intellectual property.

While depreciation of structures and equipment has stayed relatively constant, depreciation of IP products has gone up from less than half a percent after WW2 to more than 3.5% today.

Our economies have undergone a huge structural transformation in recent decades. In the NIPAs, the aforementioned intangibles consist of software, research and development, for example.

Software and other intangibles have become increasingly important in today’s IT based economy. However, IT is also depreciating at a rapid rate. Companies need to replace software and upgrade every few years, which obviously comes at a cost.

Unsurprisingly, the average age of IP Products of private fixed assets is just a little over 4 years, compared to 7 years for equipment, and 28 years for structures.

Imputed rents are increasing

Imputed rents have also increased significantly as a share of GDP, from about 6% in the 1980s to 8% in recent decades. A significant part of the increase in imputed rents can be attributed to rising house prices.

Last but not least, I also deduct taxes on production less subsidies from the gross labor share. As Bridgman (2018) points out, unlike income and corporate taxes, production taxes cannot be attributed either to labor or capital income.

An adjusted net measure of the labor share

Following Rognlie (2016), Bridgman (2018), and Karabarbounis and Neiman (2018), for example, I calculate an adjusted (net) measure of the labor share. More specifically, I factor out depreciation, imputed housing costs, and taxes on production less subsidies.

Looking at the adjusted labor share series, one reaches a vastly different conclusion than before. More specifically, the net wage share is not considerably lower today than a few decades ago.

As explained above, this means that the fall in the gross labor share does not imply a redistribution from labor income to capital income. In fact, capital income and profits do not seem to be considerably higher today than a few decades ago.

Instead, almost the entirety of the fall of the gross labor share can be explained by rising imputations, meaning an increase in the economy-wide depreciation rate as well as rising imputed housing costs.

Obviously, this does not imply that all is well. The rising imputations as a share of GDP, especially increasing depreciation rates, are in my opinion still a concerning trend albeit a different one than what many other people have proclaimed when lamenting the fall of the wage share.

Disclaimer: We don’t usually have views and opinions about economic and financial states of affairs, (not ones that we express publicly as a company, anyway). We do believe, however, that people can and do appreciate a variety of perspectives. What you’ve just read is the perspective of the author. While we think our writers are very smart, Macrobond Financial does not expressly endorse the views presented here. And, as the old adage goes, you shouldn’t believe everything you read (not without finding the data, performing a few analyses and presenting it in a nice chart). We want to make it clear that we are not offering this information as investment advice. That being said, if you have Macrobond, you can easily check everything that’s mentioned here, and decide for yourself. If you don’t have Macrobond, now you have a great reason to get it.

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