By Peter Orszag
October 19, 2011 | Bloomberg
In Economics 101, students learn that the share of national income received by labor stays roughly constant with the share received by capital. This is the first of "Kaldor's stylized facts," articulated half a century ago by the Cambridge economist Nicholas Kaldor.
Recent experience betrays this lesson. Over the past two decades -- and especially since about 2000 -- the share of national income that flows into wages and other kinds of worker compensation has been plummeting in various countries.
Labor share normally bounces around over the business cycle, but given how long the decline has lasted, it can't be dismissed as cyclical. And this partly explains the kind of anger and frustration that is fueling the Occupy Wall Street movement worldwide.
The numbers involved are substantial: In 1990, about 63 percent of business income in the U.S. took the form of wages and other types of labor compensation, according to data compiled by the Bureau of Labor Statistics. By 2005, that figure had dropped to 61 percent. And by the middle of this year, it had fallen to 58 percent. (Similar declines have occurred in other data sets, but are milder when the analysis includes the government, rather than only the private sector.)
The difference from 1990 to today -- about 5 percentage points or so of private-sector income -- amounts to more than $500 billion a year. In other words, if labor's share hadn't fallen, labor income would be $500 billion higher this year.
Similar decreases have been occurring in other countries. In Germany and France, the labor share fell about 4 percent from 1995 to today, and it dropped about 6 percent in Australia and Japan during the same period. As Francisco Rodriguez and Arjun Jayadev wrote in a November 2010 paper for the United Nations, the labor share across the globe has "been subject to a consistent decline over the last two decades, contrary to the (earlier) received wisdom of a constant labor share across most regions in the world."
Why the drop? Part of the reason is that the advanced economies have been shifting toward certain types of services and advanced manufacturing that have lower shares of labor income. But that explains only a small part of the decline. Even within such sectors, the share has been falling substantially. What's causing that?
The two primary drivers are globalization and technological change. From 1980 to 2005, as the world became more integrated, the effective labor supply available on a global basis expanded by 100 percent to 300 percent (depending on how the estimates are done). That increased competition has pushed labor compensation down in the industrialized economies.
The effects of technological change are more subtle. As automation reduces the demand for workers, the labor share initially falls, but in time, as people adjust their skills to suit the new technology, the effect is often reversed.
In a 2007 paper for the International Monetary Fund, Florence Jaumotte and Irina Tytell tried to parse the various causes of the declining labor share. In the U.S., the U.K., Australia and Canada, the economists concluded, labor globalization and technological change played roughly equal roles, and crucial ones at that. In European countries and Japan, technological change was more significant than labor globalization. Other factors --including unions and privatization trends -- have been found to be influential, but labor globalization and technological change loom as the dominant forces.
Further Decline Ahead
Over the next decade, the global pool of labor is likely to expand rapidly for many reasons -- as more workers in China obtain advanced educations and migrate to the coastal cities, for example.
(Interestingly, the labor share has also been declining significantly in China. Part of that appears to be a statistical error, and the remainder reflects an ongoing shift from agriculture to manufacturing. The early stage of that process often involves a decline in labor share, which is then followed by an increase as the development process continues.)
The labor share in the U.S. will probably bounce up and down as the economy slowly recovers. Unless we are somehow going to cut ourselves off from the world, though, we face the prospect of a continued downward trend in the labor share. The trite response to this reality is to call for more education and better training for workers, and more investments in research and development as well as infrastructure. It's true that all such actions would help. But they take time, and even then they would probably only take some of the edge off the decline, not fundamentally reverse it.
No wonder the frustrated Wall Street protesters lack any specific proposals for change: We are effectively missing $500 billion a year in wages, and no one has a credible set of ideas that would bring it back.
(Peter Orszag is vice chairman of global banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)