Declining Labor Shares and Rising Corporate Profits

A few people have been posting about the global trend of falling labor shares (e.g. Tim Taylor) so I thought I’d highlight a paper by Loukas Karabarbounis and Brent Neiman on the subject. Here’s a non-technical summary.

I haven’t had a chance to read through the model and all of the paper as carefully as I should (so apologies if I don’t get this exactly right), but my understanding is that they attribute about half of the decline in labor share to large declines in the (relative) cost of capital since the early 1980s. Since capital and labor are somewhat substitutable, aggregate expenditure shares on labor decline when capital gets relatively less expensive.

Here are two charts from their paper that provide suggestive evidence for their story from (1) the global time series and (2) cross-country correlations between relative price of investment and labor share changes.

labshare_fig5fig6So where does the money that isn’t going to labor go? They show it goes to corporate profits, which is composite of corporate saving and dividends.

In response to a decline in the investment price, firms substitute away from labor and toward capital, reducing labor’s share. They increase corporate saving as the cheapest means to finance this expansion of the capital stock, increasing the share of corporate saving.

This story can be seen in terms of a diagram from their paper (with added arrows). Corporate Value Added hasn’t changed much, labor shares have decreased, and corporate profits have increased. 

laborshare_fig3_oz

Figure 9 empirically shows the rise of corporate profits (in blue) despite relatively flat corporate value added (in red) as a share of GDP.

labshare_fig9

Finally, I should note that some portion of profits represent the return to capital (since rK wasn’t fully accounted for in “other payments to capital” in the above figure). Many older papers (e.g Katz and Summers or Basu and Fernald) emphasize that even though profits exist, economic rents are small once you deduct the normal return to capital from profits. I have yet to find more recent estimates of the magnitude of rents that incorporate these recent trends – please let me know if you know of any. I suspect that rents have been growing and would love to be able to point to rigorous work that shows how economic rents have evolved over the past 30 years.

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About ozidar

Graduate student at UC Berkeley, studying public finance & labor economics. https://sites.google.com/site/omzidar/
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6 Responses to Declining Labor Shares and Rising Corporate Profits

  1. Brendon Bernard says:

    It seems like the author’s of the paper are reasoning from a price change. The key question is what caused the cost of capital to decline for 30 years. There could even be a case of reverse causality, where declining labor share leads to cheaper capital.

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