Tuesday, November 26, 2013

Labor Share of Income

Tyler Cowen links to new research on labor share of income from Elsby, Hobijn, and Șahin.  It's an interesting paper.  Much of the findings demonstrate the difficulty of using these statistics in a precise way.  For instance, they find that in stock options are accounted for when they are exercised, and they tend to be exercised at market high points.  So, recently, there has been a pro-cyclical quality to labor income.  There are periods of underreporting, which miss deferred income in the form of options.  Then, when the options are exercised, they create an overreporting of labor income.  They do not find evidence that reduced unionization is related to lower labor share of income.  But, they also find that the data do not support several neo-classical predictions about relationships between labor and capital, and they also find that more than 3% of the decline in labor share is due to offshoring.

Looking at this post I did on this basic topic, I should have included this graph:
This is compensation as a portion of GDI.  My feeling is that this is still within a fairly tight long term range, but the research noted by Tyler is basically looking at the decline since the 1970s.  (The proportions I use are from table 1.11 of the BEA interactive data tables for National Income and Product Accounts.  Levels can differ, depending on the denominator used, etc., but the trends tend to be the same.)

I tend to have a queasy feeling about the implied moral notions that discussions about these things tend to carry.  There is usually a sense that declining labor share is a problem to be solved.  But, who is to say that labor share hasn't been too high?

I am going to eat some sugar plums tonight, then go to bed and dream of a world where the social convention is to wonder how we can increase capital's share of GDI.  Does that make me a bad person?  If you think so, then I encourage you to visit a place where 100% of compensation goes to labor.  They exist.  Floors tend to be made of dirt there.  You might find that you want to take the first available flight back home from there...except they won't have planes, because planes require capital.  Many places like that are now seeing vast improvements in the conditions of the typical household.  The places that are doing that are doing it by encouraging the profitable allocation of private capital.

My point is that it is very hard to determine the optimal proportion of income that should go to labor.  A mental model that induces concern for decreasing Labor Share but never induces concern for decreasing Capital Share is not a coherent model.  It's a very effective, and widely utilized, model for social posturing, but it would be practically useless as an informational tool.
If we imagine the range of possible outcomes for Labor Share of Income, a society where 100% of income goes to labor is generally going to be a subsistence society.  These societies are usually characterized by a universal lack of individual property rights, so that legal or cultural norms impose a negative rate of return on individual saving, and thus, there is little accumulation of wealth or capital.
A limited access society, where property rights are monopolized by a small set of owners and the mass of the population works for subsistence wages and has a limited ability for accumulation or savings, would have a very low Labor Share of Income.
Developed, free societies with universal property rights populate the area around the tip of the hump.  These societies generally allow for an emergent equilibrium level of Labor Share of Income that moves dynamically around some range.
The level of potential income, optimal labor share, and actual labor share, are constantly moving due to changing cultural, technological, and legal contexts.  If this relationship is smooth and continuous, then we would expect Labor Share of Income to decrease as a result of non-universal capital-related policies or policies that prevent entry into specific markets (these policies include ethanol mandates, health insurance mandates, regulated monopolies, the FDA, non-competitive government procurement, zoning restrictions, etc.).  Universal restrictions of capital would tend to increase labor share (high taxes on capital, pro-labor contract regulations, high levels of public employment, etc.).
To the extent that there are forces pulling in both of these directions, the level of potential income (the height of the hump) is reduced.  If labor share is to the left of the hump, and our reaction is to implement confiscatory capital policies, we won't be climbing the hump.  We will just be lowering the hump as we pull labor share back up.  If we are truly to the left of the hump, the appropriate policy reaction would be to decrease some of these non-universal capital policies.
Even though the list of policies above is long, the US has been better than most at avoiding non-universal capital policies, and it also has a higher labor share than other economies.
But, how can we know if we are to the left of the hump?
The Gross Domestic Income that is not taken by labor is, for the most part, taken by capital.  But this is divided between Consumption of Fixed Capital, which is a measure of deterioration and obsolescence of capital assets, and Net Operating Surplus, which is the remaining income to capital, in the form of profit, interest, and rent.  What we can see here is that, over time, there has been a large decrease in the relative income to capital.  We would expect this to coincide with an increasing Labor Share of Income.
But, as we can see here, this has been a product of an increasing capital base.  An increasing amount of capital has been put to work in the American economy.  Decreasing marginal returns have led to a lower proportional income to capital, but the absolute return to capital has remained within a relatively narrow band.  So, the lower labor income has come at the hand of higher capital deployment, and not from higher capital income.
This is understandable.  As we continue to become wealthier, we should have more capital to deploy.  The net effect of this on Labor Share of Income is not clear.  Long term cultural and technological developments could lead to higher, lower, or stable income shares.
In the end, I propose some basic ideas to guide discussion on this issue:
1) Any discussion prefaced on a naïve notion that decreases in Labor Share of Income are bad, ipso facto, will be unlikely to lead to a productive outcome.
2) This does not make a good proxy for income inequality issues, since high incomes can be a part of both labor and capital.  CEO's and high status athletes earn mostly labor income.  Elsby, Hobijn, and Șahin note that while labor income variance has increased, the increased variance of incomes among proprietors dwarfs that of payroll labor.  The sources of inequality are complex, and I wonder if labor markets mitigate these variances as often as they promote them.
3) A discussion framed in terms of shares of income is framed to miss the most important factor - the height of the hump.  This chart shows the actual Compensation of Employees, over time, compared to the range of compensation share over the past 65 years.  The slope of these trends is, far and away, the most effective way to improve the lot of the average laborer.
If we are considering a policy that is meant to correct the level of Labor Share of Income, which has an ever-moving and unknowable optimum, and if that policy will arguably lower the rate of growth for the economy as a whole, then that policy needs to have a very high bar to top in terms of effectiveness and coherence of purpose.

On the one hand, the research of Elsby, Hobijn, and Șahin suggests that my idealized model certainly won't be supported by all of the data.  But, I think we tend to have an aesthetic response to these issues that leads us astray.  If we see a shrinking labor share of income, we think of the poor worker, putting in long days and barely making ends meet.  We don't have a comparable image when capital's share of income shrinks.  (Why don't we think of our widowed grandmother, trying to extend her nest egg in the face of negative real interest rates?)  But, the tip of the hump in my model is not utopia.  It's a place where there will still be, for now, working poor families.  This is unrelated or tangentially related to labor share of income.  We shouldn't be led by the realities of our current distribution of scarcity away from the most effective means to improve it.  Some of those solutions may be redistributional, but it might be worthwhile to aim for policies that reduce the drag on universal returns to capital as opposed to policies intended to increase that drag, in some sort of misplaced attempt at fairness.
PS:  "Negation of Ideology" comments at themoneyillusion.com.  Here is the beginning and end of the comment:
"People confuse the distributional issue with the labor/capital split. The ideal obviously is for Capital to receive 100% of national income and labor to receive 0%, and the ownership of Capital to be very widespread...............If a farmer that owns his own farm gets a tractor that cuts his workload in half is he angry?"
His comment is profound.  But, it gets at the difficulty of achieving utopia.  Capital is risk.  Accumulation is risk.  Whereas information asymmetries probably mitigate inequality in the labor context, in the capital context outcomes multiply upon themselves, whether those outcomes are skill-based or simply from bad luck.  Could the 100% capital-utopia be stable?

The conundrum is that, clearly, a capital-heavy society is better than a labor-heavy society.  But, a capital-heavy society is probably inevitably less stable with more diverse individual economic outcomes.

1 comment:

  1. ' But, I think we tend to have an aesthetic response to these issues that leads us astray. '

    No kidding. And even for people with North Carolina State Phds;


    I'm tempted to make it to the next Seattle City Council hearing and read your post into the record.