By Margaret Jacobson And Filippo Occhino April 18, 2013 Indiana University Kelley School of Business Declining Labor Share and Rising Income Inequality

These are our views and not those of the Federal Reserve Bank of Cleveland or the Federal Reserve System…

Outline Define labor share Document the decline in labor share Causes of the decline Explore whether the decline can explain increasing income inequality

Labor Share Definition

Labor Share Calculation

Labor income as a share of total income Labor Share Source: Bureau of Labor Statistics/National Income and Product Accounts/authors’ calculations CBO Data BLS Data NIPA Data

Interpretation Why is labor share not constant? Why is it trending down?

Causes of the Decline in Labor Share

Note: real calculations are based on the implicit output deflator Real Wage and Real Productivity: Nonfarm Business Sector Source: Bureau of Labor Statistics

Growth Rates in Select Periods Annual Percent Change Note: real calculations are based on the implicit output inflator

Causes of the Productivity-Wage Gap Decreased bargaining power to labor -Declining union participation Higher Returns to technology -A given worker, with a given endowment of capital can now produce more output in the same amount of time. Increased globalization -Labor intensive business can find cheaper labor abroad

Caveats – Declining Labor Share Not limited to the U.S. -OECD Employment Outlook (2012) shows that labor share declined from 1990 to 2009 in 26 of 30 countries -Karabarbounis and Neiman (2012) show that 36 of 51 countries saw a decline from 1975 to 2007

International Labor Shares Source: Karabarbounis and Neiman, “Declining Labor Shares and the Global Rise of Corporate Saving”

Depends on how you measure labor share -Rupert-Gomme (2012) argue that by adding housing flows labor share is steady Caveats – Declining Labor Share

Measurement Matters (Rupert-Gomme) Source: Econsnapshot, Peter Rupert

Classification of Income -S-corporations may have reclassified labor income to capital income -Sole-proprietors and partnerships -Gollin (2002) Labor income of the self employed is often treated as capital income Ambiguous income Caveats – Declining Labor Share

Impact on Income Inequality If productivity is increasing faster than wages, more income is then accruing to capital share Capital owners tend to be those in the higher income strata If a larger share of total output is accruing to those with higher incomes, the decline in labor share could be leading to increases in income inequality

Corporate Profits as a Percent of GDP and Labor Share Percent Source: Bureau of Economic Analysis Percent Labor share (right axis) Corporate profits

Definition of Income Inequality Dispersion of household income relative to the average household income. There are limits to what income inequality measures

Household Income Shares Percent of total income Source: Census Bureau

Household Income Shares Average growth rate Source: Census Bureau

Gini Index

Rising Income Inequality Most of the increase since 1980 is due to returns to education Wage differential between high-skilled and low- skilled -More concentration of income at the top of the distribution Labor Share -Only responsible for 2.3 percent of 23 percent of increase in the gini coefficient from 1970 to Concentration of capital and labor income has more of an impact

Income Concentration

Conclusions In theory, labor share should be constant but data shows a decline over the past 30 years. Productivity growth outpacing wage growth Income inequality has been rising since the same period labor share started falling. Declining labor share is only partially responsible for the increase in income inequality. Other factors such as increased concentration of labor income and capital income are larger drivers of the direction of income inequality.