Liberals Tell the Truth About Falling Income, but Not the Reason For It

Many on the left have bemoaned a decline in labor's share of national income and have offered this slide as evidence of business owners exploitation of labor. Their assumption is that labor's share must be down because of unfairly low wages. The reality is, in fact, the complete opposite.

Data from the Bureau of Labor Statistics detail changes in the amount of labor and capital used as inputs in private businesses (the government sector is excluded), changes in their per unit compensation, and changes in their share of national income. These data show that in 1987 labor's share of income was 62.8 percent while capital received 31.1 percent. Sure enough, by 2011 labor's share of income had declined to 59.5 percent while capital's share had risen to 34.5 percent. Liberals are telling the truth about the shift in income shares, just not the reason for it.

Examining the same data further we find that over the same 1987-2011 time period the amount of labor used in production has risen by 29 percent. However, simultaneously, capital inputs have grown by 123 percent. That is, capital's share of the inputs used to produce all the goods and services in the economy has grown about four times as fast as the use of labor. It stands to reason, therefore, that the share of income paid to that capital would rise in some proportion to that increase in the use of capital.

In fact, over this 1987 to 2011 period, the value of output rose by 61 percent on a per unit basis (essentially a measure of inflation in private sector goods and services). The price paid per unit of capital rose by 55 percent over that same time period, slightly below the rate of inflation in the selling prices of the products made using that capital. In contrast, the compensation per hour for labor has actually grown by 157 percent, a rate more than twice that of output price.

Looking at these numbers reveals, that while labor's share of national income has certainly declined, that decline is less than could have happened. Labor productivity, measured as output per labor hour worked, has increased by 70 percent. This is due in part to a more educated workforce and in part to the increased capital that workers have to utilize. However, when workers are made more productive through an increase in the capital-labor ratio, some of the extra income earned by businesses must go to pay for that additional capital. Not all the extra profits can go to labor since labor is not responsible for all the extra work being done.

Academic research by economists Loukas Karabarbounis and Brent Neiman at the University of Chicago demonstrated that this trend has been accelerated by low interest rates and other factors that make the price of capital low, explaining the majority of this shift. Interestingly, this analysis suggests that the current Fed policy of near zero interest rates is an anti-labor policy likely to contribute to a continuation of the trend toward labor receiving a smaller share of national income.

Taking into consideration the changes in the amount of labor and capital being used in private sector production, labor seems to have been treated more than fairly. In fact, if the shares of national income had shifted simply in line with the changes in the amount of labor and capital inputs used, labor's share today would be 50.6 percent and capital's share would be 43.4 percent. Compared to these numbers labor's current share of national income of 59.5 percent looks pretty good.

Business owners have shifted their production technology in favor of capital over the past fifty years. A primary motivation has been that capital is less expensive than labor as a way to increase productivity. Advocates for workers need to understand that advancing policies to make labor more expensive, such as an increase in the minimum wage, are exactly the wrong way to reverse this trend. Better would be policies to make labor more productive, effectively lowering its price when measured by the amount of output it can produce. Economic decision making is centered around relative prices. As long as capital is cheap, labor's share of national income is unlikely to rebound.