Compensation, Productivity and Labor Share

Productivity outpaces real wages, deflated using the output deflator, or using the CPI.

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Figure 1: Log productivity (blue), log real compensation using output deflator (red) and using CPI (green), in the nonfarm business sector, all rescaled 2001Q1=0. NBER defined recession dates shaded gray. Source: BLS via FRED, NBER, author’s calculations.Note that a large portion of the gap between productivity and real compensation is due to the use of the CPI index as the deflator. Nonetheless, the gap still exists using the output deflator. And that gap (mechanically) explains the declining labor share of income in nonfarm business sector.

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Figure 2: Share of labor income in nonfarm business sector, 2009=100. Red lines are for 1967Q1-2000Q4 and 2001Q1-2013Q3 linear trends. NBER defined recession dates shaded gray. Source: BLS via FRED, NBER, author’s calculations.The rate of decline is 0.8 ppts of GDP per annum after 2000, while it is a mere 0.1 ppts from 1967-2000. What’s the explanation for this precipitous decline in the labor share? I’m going to appeal to a recent (Fall 2013) BPEA article by Elsby, Hobijn and Sahin:

Over the past quarter century, labor’s share of income in the United States has trended downwards, reaching its lowest level in the postwar period after the Great Recession. Detailed examination of the magnitude, determinants and implications of this decline delivers five conclusions. First, around one third of the decline in the published labor share is an artifact of a progressive understatement of the labor income of the self-employed underlying the headline measure. Second, movements in labor’s share are not a feature solely of recent U.S. history: The relative stability of the aggregate labor share prior to the 1980s in fact veiled substantial, though offsetting, movements in labor shares within industries. By contrast, the recent decline has been dominated by trade and manufacturing sectors. Third, U.S. data provide limited support for neoclassical explanations based on the substitution of capital for (unskilled) labor to exploit technical change embodied in new capital goods. Fourth, institutional explanations based on the decline in unionization also receive weak support. Finally, we provide evidence that highlights the offshoring of the labor-intensive component of the U.S. supply chain as a leading potential explanation of the decline in the U.S. labor share over the past 25 years.

So Figure 2 suggests the decline in labor’s share is partly a statistical artifact. However, capital substitution and import competition do seem to be important drivers of the actual decline. As does the lack of unionization. Figure 10 from the paper highlights the relationship.

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Figure 10 from Elsby, Hobijn and Sahin, “The Decline of the U.S. Labor Share,” BPEA (Fall 2013).While it is difficult to imagine arresting the effect of the first two factors, it seems to me the third might be amenable to government policy — or at least policy measures aimed at dismantling unions.

This piece is cross-posted from Econbrowser with permission.