Labor’s Declining Share Is an International Problem

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform - Why We Need It and What It Will Take.”

In a recent post, I noted the declining share of national income going to labor in the form of wages and benefits and the rising share going to capital income like dividends. Before talking about solutions to this problem, it’s important to understand that this is a worldwide phenomenon not confined to the Unitd States. This fact is documented in recent studies.

For many years, economists said they believed that labor’s share of income was an empirical relationship so stable that it was virtually a constant. In fact, it was called “Bowley’s law,” after the British economic historian Arthur Bowley, who first identified it almost 100 years ago.

It takes time for economists to separate trends from the normal ups and downs in various types of economic data, and it took a while before they realized that labor’s falling share went beyond what could be explained by the recent recession. The latest Economic Report of the President (see Pages 60-61) discusses this phenomenon and suggests that it results from changes in technology, increasing globalization, changes in market structure and the decline of labor unions.

More importantly, the report notes that labor’s falling share is even m! ore pronounced in other developed countries. The reason this is important is that it allows us to avoid focusing too much on policies and factors unique to the United States. For example, labor’s share of income has fallen even in countries with much stronger protection for labor unions and greater unionization of the labor force.

“Other Developed Countries” refers to the member states of the Organization for Economic Cooperation and Development. The United States labor share includes imputed proprietor’s income. The O.E.C.D. labor share excludes the farm, mining, fuel and real estate sectors, and is aggregated by the Council of Economic Advisers on an annual basis for 22 countries using G.D.P. weights at current exchange rates.

Studies by international economics agencies have begun looking at the problem of labor’s declining share of income across national boundaries.

Last year, the Organization for Economic Cooperation and Development devoted a long chapter in its annual Employment Outlook to the problem. It noted that labor’s share appears to have started falling more than 30 years ago. Since the early 2000s, ! labor’s! median share of income across all its member countries has fallen to 61.7 percent from 66.1 percent.

To show the order of magnitude of that decline, if labor’s share of income in the United States had fallen by the same percentage, workers would be receiving more than $600 billion less aggregate income this year alone. With about 144 million people working, that’s a loss of more than $4,000 per worker.

And remember that labor’s share includes benefits, so it is not just an issue of falling wages due to rising health insurance costs for employers, as some economists assert.

Among the key points made in the O.E.C.D. report is that labor’s share has not fallen equally across industries or classes of workers. The share of income going to highly paid workers has increased in many cases, while that going to low-paid workers has fallen. Thus income inequality has increased.

The report identifies the substitution of capital for labor in many industries as a cause of labor’s declinng share. A shorthand term for this is “automation,” but it really goes beyond simply replacing workers with machines. It also includes the spread of technology, like computers and the Internet, that has increased the productivity of some workers, allowing them to do the work of several workers in the recent past, but not others.

But as a recent report from the International Labor Organization points out, the gains to higher productivity resulting from technological innovation are not going entirely to workers. It says that since 1999, average labor productivity in a cross-section of countries has increased twice as much as wages.

A new study by Loukas Karabarbounis and Brent Neiman of the University of Chicago’s Booth School of Business identifies the low cost of capital as a key source! of labor! ’s woes. Because of low interest rates and low taxes on investment, companies have been encouraged to substitute technology, machinery and equipment for labor, which explains about half the decline in labor’s share of income, according to their estimate.

Interestingly, this means that rising interest rates, which have roiled the bond market in recent weeks, are part of the solution to labor’s declining share of income. By raising the cost of capital, higher rates will make labor relatively more attractive vis-à-vis capital. Higher taxes on capital would also have that effect as well.

As Professor Neiman put it in an e-mail to me,

Rising real interest rates, higher prices of investment goods, higher depreciation rates, or even increases in corporate tax rates would (everything else equal) push labor’s share upward as they all generate increases in the cost of capital.

This is important because many economists routinely assert that more capital investmnt is critical to increase productivity, which, in turn, will automatically lead to higher wages. While this is undoubtedly true up to a point, we may have passed the point where it is still true in economically advanced countries such as the United States.

It may be that so much of the gains from productivity now go to capital and to the most highly paid workers that one can no longer say, as a truism, that more investment is per se a good thing for workers.

Because there is so much concern right now about the economic consequences of higher interest rates, which are almost universally viewed as negative, I would like to note that higher rates will raise the income of many middle-class people who tend to keep their savings in bonds, certificates of deposit and savings accounts that yield very little return.

As the table shows, interest income has fallen sharply since 2008, when the economic crisis forced the Federal Reserve to lower interest rates, taking hundreds of billions of do! llars a y! ear out of the pockets of middle- and working-class families. By contrast, those with high incomes tend to put more of their savings into stocks that have benefited from a rising stock market, thus contributing further to income inequality.

Department of Commerce

In short, from the point of view of workers and those with modest savings, rising interest rates are unambiguously a good thing, because they will raise personal income and labor’s share of national income.