David R. Henderson  

The Decline in Labor's Share of U.S. Income

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Last month, Timothy Taylor, the Conversable Economist, posted an interesting item on the decline in labor's share of income. First some background.

I've taught economics since 1975, except for about 4 years (1979-1980 when I was a senior policy analyst at the Cato Institute, 1982-1984, when I was in the Reagan administration, first in the Labor Department and then at the Council of Economic Advisers, and 1990-91, when I went on leave without pay to put together The Fortune Encyclopedia of Economics. In most of the introductory courses I taught, I did a section on income distribution. One number I highlighted throughout this time was that the labor share of income in the United States was pretty much a historical constant, at about 62 or 63 percent. About 2 years ago, I decided I needed to update that section--and found that I was about 10 years out of date. Starting around 2001, the labor share of income began to decline. It's now about 10 percentage points below where it was, with labor getting only a little over half of income. And, as I understand it, it cannot be explained by the increasing share of labor income that is in the form of employee benefits: that's already taken account of in the data.

I highlighted that fact in a course last fall and told the students that although I'm no Marxist, I did find this a little concerning. I was actually gratified when some of the students fired back that why should I care if workers were getting higher real incomes than they were, which other data I had shown them demonstrated to be the case. You're right, I answered, but somehow I still find this concerning.

Then I read Tim Taylor's piece and became less concerned. Basically, he highlights an article by Roc Armenter, a vice president and economist at the Federal Reserve Bank of Philadelphia. (Taylor links to the article, but every time I click on the link I get a pdf file. So if you want the article, go to Tim's post.) I think that, although Tim mentions it, he goes too quickly past one of the main reasons for the decline, namely a change in measurement.

Armenter writes:

Indeed, until 2001, the BLS's [Bureau of Labor Statistics] methodology assigned most of proprietor's income to the labor share, a bit more than four-fifths of it. Since then, less than half of proprietor's income has been classified as labor income.

How important is this? Armenter shows a graph in which he keeps the BLS's pre-2001 methodology. With no change in methodology, labor's share falls, but only from about 62 or 63 percent to about 59 percent. This is still a substantial fall, but had I known this when I was teaching last fall, I would still have pointed it out, but would not have expressed nearly the concern I did.

Armenter, using other measures, goes on to show a substantial decline. He also claims that real wages have stagnated. I think he's wrong on this because real wages are usually computed using the CPI, which overstates inflation. Interestingly, Armenter labels his Figure 4, about labor productivity versus real wages in manufacturing, "Productivity Rose While Wage Growth Stalled." I don't know what "stalled" means. His figure shows that real wages grew more slowly and that they didn't grow as quickly as labor productivity. But real wages, even given Armenter's imperfect measure (and assuming his graph is accurate), grew.

Is all of this a puzzle? Yes, and that, to his credit, is how Armenter presents it. It's also how I will present it: not necessarily a concern, but definitely something for which economists don't have a clearcut explanation.

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COMMENTS (19 to date)
HH writes:

When I see the stats re drop of labor's share of income, I wonder if demographics were taken into account:

1. Aging. As boomers retire, their income is from capital, not labor. More retirees = more capitalists.

2. Labor force. We keep hearing that the labor force participation rate is at its lowest in decades. Seems pretty clear that labor's income should thus also fall.

Am I missing something?

Bostonian writes:

Does more capital per worker cause the labor share of income to decline? If so, as a society gets wealthier and more technologically advanced, a larger share of income will go to capital.

David R. Henderson writes:

When I see the stats re drop of labor's share of income, I wonder if demographics were taken into account:
They don’t appear to have been.
Am I missing something?
Read the article and see.
Does more capital per worker cause the labor share of income to decline?
Depends on elasticity of substitution.

David writes:

What about a shift from pensions to 401ks?

Kevin Erdmann writes:

It's all housing.

Here is a graph of corporate profit+interest income plus proprietors income (the graph is stacked). It's riding along a trend that has been flat as a pancake for 60 years.

I have been putting together a narrative that pins a lot of this on the limits to building in the major cities. The cities can't bring in more households to capture the value that the cities have created because they won't allow much residential building, so wages in those cities (mostly NYC & SF area) get bid up, but in the end a lot of those wages are claimed by real estate owners. First, wages are bid up because of the lack of labor that can get into the city, then labor bids up the price of housing in an attempt to capture those wages.

This creates at least 3 significant outcomes:

1) high productivity labor that can leverage the value of those cities more captures more of labor's share, increasing inequality within labor compensation. (Some research has shown that a large portion of recent inequality comes from just a few counties.)

2) Real wages appear to stagnate because the bidding war for prime real estate is measured as inflation. We use inflation as a proxy to adjust for an unstable numeraire, but in this case the inflation is coming from artificial supply constraints, so inflation is overstated, lowering measures of real income growth.

3) That lost real income is going to rent payments that are increasing the income of real estate owners (in many cases, simply the households themselves, as homeowners). So, this same phenomenon creates a shift from measured labor income to capital income - but not corporate income.

It is possible that most of the shift in all of these factors can be pinned down on this one issue. Through the combination of foresight and good luck, NYC and the San Francisco area put themselves in a position where high density, itself, was a large factor in their value, and just when that foresight is paying dividends, they have decided that they are unwilling to do the thing they were built to do - hold a bunch of high-rise residential housing. The local policies of these cities has led to a measurable decline in incomes.

Here is one attempt to measure the problem.

Kevin Erdmann writes:

Here's a 2nd graph to compare to the graph in my first comment. This is a stacked graph of consumption of capital and rental income as a share of GDI.

Kevin Erdmann writes:

Here's one more graph: Net housing operating surplus (which includes income of both the equity holder and creditor) and inverted compensation, both as a share of GDI

David R. Henderson writes:

Thanks, Kevin. Quite striking.

Capt. J Parker writes:

Not to detract from Kevin Erdmann's thesis but Tyler Cowen blogged about research that says the fall in labor share of output is because of too little capital. Quoting Cowen "A new and important paper by Robert Z. Lawrence. It is a little hard to excerpt, but the core messages are pretty simple:
1. Labor and capital are mostly complements.
2. The recent problems of labor are due to a lack of capital, not substitution of capital for labor.
If Lawrence is right — and he has plenty of data on his side — a lot of what you read about these topics is wrong, at least circa the status quo. And the idea that we need stiffer taxes on capital income could be disastrously off base. This paper is interesting throughout, yet I predict it will be largely ignored for its inconvenient nature."

James Hartwick writes:


Just to make sure I understand you correctly: You're saying that a few cities or urban areas had such an increase in real estate prices that the impact on inflation nationally was enough to lower labor's real income on a national level?


I remember Piketty's "Capital" stating the rule that labor gets two thirds of the national income and capital gets one third, and that this was a good overall rule for the last couple centuries of industrial capitalism. Of course that's just a rough rule of thumb (and of course I might be misremembering).

Gregor Schubert writes:

While I think there may be merit to the explanations that focus on changes in US national accounting methodology, CPI biases or house prices, it is important to keep in mind that the decline in the labor share is an international phenomenon that has been occurring across the OECD since the 70s. As a result, part of the explanation needs to be something that is happening to all those countries at the same time. I would suggest that this may be related to macroeconomic risks, but perhaps the house price effect is global as well?

See slide 22 in the presentation here for the marked downward trend in labor share in the 6 biggest OECD economies (I made this graph based on data by Karabarbounis and Neiman (2014)):

Robert Thorpe writes:

The Penn World Tables have done a similar exercise. They have adjusted for the changes in methodology over the years. According to them, between 1950 and 2008 labour share varied from 63.4% to 67.8%. In 2009-2011 it varied from 62% to 62.6%.

What's I find interesting about that is the wider range than the one David stated. The PWT data for 1950-2008 has a range of 4.4%, adding in the subsequent years only widens that range to 5.8%.

Other countries show wider ranges for this than the US. The UK data shows a fluctuation of 5.9% in 5 years, for example.

Kevin Erdmann writes:

James, yes that is what I am saying. Actually, no....That was the case until 2006. Since 2006, mortgage markets have been constrained by monetary and regulatory policies, so since 2006, there has been a nationwide supply constraint.

Here is a post
where I worked through some estimates of the effect on real incomes. In total, for the period since 1995, the average household probably has 5% lower real income because of the housing supply constraint. About 1/3 of that comes from the Case-Shiller 10 cities, and among those cities, most of the problem is from California, NYC, and Washington DC. Of course, households who own their homes outright earn that back as self-landlords, so the net effect on them may be negligible, though it means they are earning more from capital and less from their wages. The worst are low income renters in the problem cities. We can see the tension this creates among working class renters in the cities, though this unfortunately tends to lead to anger against builders instead of leading to demands for more supply, and only exacerbates the problem.

If the national housing market ever becomes functional again, the excess housing expense outside these cities should abate, and the problem cities would probably account for most of the problem.

Gregor, I think you are right about the global reach. Rents and home prices have risen across the anglosphere. The major cities in Australia, England, etc. seem to all face these regulatory building constraints. I don't know if it is cultural, technological, etc. In the US, it appears that households tend to accept housing expenses up to about 18% of total consumption, on average. Maybe it's a sort of arbitrary issue, where we have reached a point that extra square footage in the hinterlands doesn't provide as much marginal utility, so households with 18% of their potential spending burning a hole in their pockets begin, in the aggregate, to bid up real estate based on location. And, firms on the technological frontier seem to be drawn to these commercial centers. There must be an unusual benefit to being in these cities compared to previous times. The common problem of supply problems in these cities causes that productivity to be captured in rents instead of being distributed among new entrants.

Pajser writes:

The combination of being "absolutely better off" and "relatively worse off" is not simple; the legendary cake doesn't increase uniformly; if number of cherries in the cake is nearly constant, the combination above means that one will get bigger part of the cake, but with less cherries. Therefore, even if one is "absolutely better off" in terms of market value, the utility of goods and services he can obtain can be worse. So, yes, it is the problem from the wide variety of the political positions.

The source of the problem? I think that capitalism has tendency to concentrate capital, converging toward society in which one man owns the world, everyone else works on subsistence level. If such tendency exists, the number of people employed in average capitalist company should grow. I am looking at USA data for 1988-2011, and it confirms that thesis. Number of employees in 500+ companies increased from 40 to 58 millions. In the same time, number of employees in 500- companies increased from 48 to 55 millions. I think that such tendency can be counteracted only through political action.

Jacob writes:

I have no idea how the increase in the number of employees in companies both greather and less than 500 employees confirms your thesis of capital concentration. You're going to have to make a better argument than raw assertion.

The housing stock argument is particularly interesting, especially as we see the effect most predominantly in markets where high barriers to entry for home builders corresponds with high rents and high population densities.

Ron writes:

Re productivity growth vs. wage growth:

Does it make sense to use median wage for this comparison? Wages on either side of the median can vary widely without affecting the median. Disproportionate wage growth at the high end due to productivity gains at the high end might account for this apparent divergence.

R Richard Schweitzer writes:

The following has been raised over at Arnold Kling's site.

The concentration in this question seems to be on distribution of disposable incomes.

Let us do a Carl Jacob Jacobi inversion to examine the problem of "distribution" and look at the "creation" of income (or better yet, the creation of incomes, wealth ( accumulation of usable, durable, productive and transferable assets) and living conditions. We can leave until later those modes of distribution of the results of those creations which are other than simple distributions of income.

How shall we view the various contributions to those creations of income (or better, to include wealth creation)?

How shall we value or quantify "labor's" contributions - as "net" contributions? How shall we value or quantify other contributions - entrepreneurship, invention, physical capital (plants and machinery, e.g.)? Are there historical or patterned "Norms" for comparing those contributions? Probably NOT.

In some forms of production we observe that labor makes a smaller contribution, but those so engaged there obtain higher levels of income than those in other activities having higher labor usages and costs.

The current "macro" concepts seem to disregard that form of approach to what happens in the disaggregated economy, disregard the production (and distribution) of other than "incomes," and puzzle with the single element of incomes distributions.

R Richard Schweitzer writes:

We might also look into :

What else, other than distributions of income, do those providing labor receive in the systems of distributions of the current economies?

Do living conditions continue to "improve" (disregarding rates and forms of improvements).

Do we not observe other means of distribution (including cost transfers) of overall productive efforts (e.g., via government programs).

In the U.S. has not the direct tax burden on a large sector of "labor" been reduced far more than the decrease in "income share."

Currently, the entire distribution (benefits and burdens) system is a very different system from the classic wage system.

Pajser writes:

Jacob - number of employees in 500+ companies have grown faster than number of employees in 500- companies. It means to me that competition between employers is reduced.

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