Labor's Share of Income Is Falling

Possible Reasons for the Decline

Labor's Share of Income Is Falling
June 1, 2015

We have heard a lot in the news about stubbornly low wage growth and income inequality. However, we do not hear as much about one of the related issues. The share of America's income that is going to labor has been decreasing for years compared to the share going to capital income such as dividends.

Different graphs are available that illustrate this phenomenon, with different numbers depending on seasonal adjustment, scaling, and whether benefits are included. All agree that labor compensation as a share of the Gross Domestic Product (GDP) is down sharply.

The drop has been significant since the Great Recession, sending labor's relative income share into unprecedented low territory (below 60% by most measures). However, the trend has really been persistent since 2001 when labor's income share was in the 66-67% range.

Robert Z. Lawrence of the Peterson Institute created an insightful graph showing the split between manufacturing and non-manufacturing industries. Non-manufacturing industries have kept a relatively stable ratio while manufacturing industries have dropped sharply. Lawrence states that the manufacturing sector accounted for 88% of the drop in labor's share between 1987 and 2011.

What is the reason for this drop? Economists disagree on the extent each factor contributes, but they do tend to agree on the following points.

  • Outsourcing and Globalization – Globalization draws labor from high wage toward low wage countries in general, which should not be a surprise to anyone. Even when operations do not move, the mere threat of being able to do so tends to keep wage pressures down. The fact that the falling labor share is even larger in other developed countries as defined by the Organization for Economic Cooperation and Development (OECD) bolsters this argument.

    Income inequality is playing a role here. According to the OECD, there is a split within the labor share decline. The share received by more highly paid workers has stayed stable or increased, while the share among lower-paid workers has fallen dramatically — and the lower wage jobs are the ones more readily threatened by outsourcing.

    Trade agreements promote growth but can do so at the expense of labor. The proposed Trans-Pacific Partnership (TPP) agreement supposedly contains labor protections, but unions are not buying it.

  • Lowered Bargaining Power – Outsourcing and a series of political losses have left labor unions with the least bargaining power in decades. Even with a Democratic administration, labor has failed to make strides.

  • Technological innovation – There have been many great technological advances since 1987, but most of those have centered on communications and information technology — non-manufacturing applications — and where innovation has been incorporated in manufacturing, it is usually to improve productivity with less labor.

  • Investment – Collective worldwide stimulus efforts have been aimed at creating business investment that creates jobs, but so far, the effect appears to have been on the capital side rather than the manufacturing side. If you accept the innovation argument above, that investment may actually be harmful to labor, as the investment money targets more efficient, less labor-intensive processes and rewards higher-paid employees.

    It may not be a coincidence that the latest decline matches up with the Federal Reserve's manipulation of interest rates to keep them artificially low.

  • Unemployment Rates – While reported unemployment rates are coming down, the more comprehensive U-6 unemployment rate that includes the underemployed, the longer-term unemployed and those marginally attached to the labor force is still quite high. Combine that with outsourcing possibilities and there is plenty of available labor on the lower-wage side, and thus few pressures to raise wages.

Realistically, there is only one way this situation improves — a booming economy that keeps employment rates high and lets natural economic forces resolve the situation. It will probably also help if interest rates are allowed to reach a natural equilibrium.

Let's hope that leaders worldwide can reverse the trend and spur a booming economy for all.

Photo © Beyter

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