Why do we care about the labour share of income?

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And by ‘we’, I mean ‘Canadians’.

A lot has been said and written about the decline in the labour share of income, usually calculated as total employee compensation divided by nominal GDP. This decline is generally regarded as a negative development: the reduction in the share of income going to workers is interpreted as a symptom of suppressed wage growth and of increased income inequality.

I don’t doubt that this is a useful narrative for understanding what has been happening in many countries, the US in particular. But I can’t see how it fits the Canadian experience. Movements in the Canadian ratio of wages to national income  appear to be a story of the denominator, not the numerator.

Here is the labour share from 1947 to 2018; the data are taken from the most recent update of Project Link:

  Labour_share_link

If we were going to interpret the labour share as an indicator of workers’ collective bargaining power, the story would go something like this. Workers’ bargaining power increased steadily during the thirty years after the Second World War, attained its peak during 1975-1995 (with substantial fluctuations), and then has declined.

The problem with this story is that it would have us believe that the period 1975-1995 was some sort of Golden Age for Labour, when in fact the exact opposite was true. Those peaks in the mid-1970s, the early 1980s and again in the early 1990s weren’t periods where workers’ power to extract wage gains was its strongest; they are all associated with recessions (you can see another spike in 2009). Capital income is far more procycical than labour income, so the percentage fall in GDP is greater than the percentage fall in labour income during recessions. Since the numerator is falling less quickly than the denominator, the labour share becomes countercyclical. Those spikes are an artifact of the cyclical properties of the components of total income, not a sign of workers’ bargaining power. I will have difficulty believing that workers’ bargaining power increases when unemployment rates go from 7% to 13%.

Now let’s set aside the recessions and look at the generally high labour shares that prevailed over this period. Were higher labour shares associated with stronger wage growth over 1975-1995?

No, they weren’t:

Real weekly earnings 1946-2018

Canada did have an extended period of stagnant wages, but it occurred between 1975 and 1995, when the labour share fluctuated around its post-war highs. The resumption of real wage growth in the past 20 years coincided with the decline in the labour share.

What about income inequality? Once again, a story in which a high labour share acted as a force for keeping income inequality in check doesn’t fit the data:

Market_gini

The Gini coefficient jumps in the first part of that sample, and only start to level off when the labour share started to decline in the mid-1990s. Statistics Canada’s Gini coefficients only start in 1976, but there’s good reason to believe that income inequality had been stable before then.

Finally, what about the steady increase in the labour share during the post-war boom? You could tell a story here of how labour’s increasing bargaining power resulted in sustained real wage growth, but then you’d have to explain why this stopped being the case over 1975-1995.

But there’s a much simpler explanation for why total employee compensation grew more quickly than GDP during the post-war expansion:

Erates_25_54

The increase in female participation rates meant that the number of people earning wages grew much faster than the population. If Canada’s production function were literally of the Cobb-Douglas form, the expansion of the labour force would have pushed down wages in order to keep the labour share constant. But if labour demand is more elastic than what the Cobb-Douglas model predicts, then total employee compensation would increase: the downward pressure on wages would be more than offset by the increase in the number of workers.

The years in which the Canada’s labour share was its highest were years in which unemployment was high, wage growth was nonexistent and income inequality was increasing. The decline in the labour share since 1995 coincided with a resumption in real wage growth, a stabilisation of income inequality, and generally lower unemployment rates.

So what’s so great about high labour shares? 

 

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