Policy and Social Implications of Declining Labor Shares

Project Outcomes Statement

The goal of this NSF grant was to develop tools to understand better the causes and implications of labor share declines measured around the world. The project had two key successes. First, together with our co-author Peter Chen, we used firm-level data from around the world to connect the labor share decline to the global rise in corporate saving. Second, we introduced and analyzed a new theoretical framework for assessing the plausibility and repercussions of various potential drivers of the labor share decline.

The first of these contributions is the paper "The Global Rise of Corporate Saving," published in the Journal of Monetary Economics. This paper used both national income accounts and firm-level data from around the world to connect the global decline in the labor share to the rise of corporate saving. We document how labor share declines resulted in a surge in corporate profits that was neither used for corporate investment nor paid out as dividends to shareholders. We demonstrate that these funds at various times were used to accumulate cash stocks or buyback shares.

In addition to documenting these key empirical patterns, which have been frequently cited and used throughout a growing literature, our paper develops a quantitative model that embeds multiple forms of taxes and aims to capture realistic corporate financing frictions. We hope the model encourages further integration of corporate finance and macroeconomic models so aggregates of the kind captured in the sector-level national accounts can be connected to data on the operations and financing of individual firms.

The second key contribution of our project is to introduce a concept we call "Factorless Income" in our paper "Accounting for Factorless Income," published in the NBER Macroeconomic Annual. We define factorless income as the residual one obtains after using standard methods to subtract from GDP payments to labor and payments to capital. We demonstrate how to measure factorless income under various scenarios that relate to the decline of the labor share and draw out implications from each of those scenarios. For example, one hypothesis is that the decline in the labor share decline has resulted from a rise in monopoly profits. To assess the plausibility and implications of this hypothesis, we attribute all dynamics in factorless income to variation in market power and discuss the resulting time series pattern for the profit share, TFP, and other aggregates.

"Accounting for Factorless Income" suggests that variation in the risk premium, or at least measurement error in the user cost of capital, plays a key role in our understanding of the labor share decline. Perhaps more important than the specific conclusions we reached, however, we hope this new terminology and way of framing key puzzles related to the labor share decline will have the longest lasting impact and become a standard way to approach and model key trends in national statistical aggregates and factor shares.

Finally, a secondary success of our project was to provide a framework helpful for thinking about labor share and inequality, developed in our unpublished paper "Capital Depreciation and Labor Shares Around the World: Measurement and Implications". There, we develop a model with a representative laborer and representative capitalist and demonstrate the conditions under which labor share declines are or are not informative for a welfare-relevant notion of inequality across the two agents.