For several decades running, the Cobb Douglas production function has been empirically shown to be inaccurate in its assumption that the share of income between labor and capital is a constant. Since World War 2, the share of output paid to labor has been falling. We now find ourselves with labor share at its lowest level since the Great Depression.
The Bureau of Labor Statistics calculates the Labor share as (Employee Compensation + Proprietors’ Labor Compensation) / Output, where the proportion of a proprietor’s’ income which derives from labor (rather than from their ownership of capital) is found by (Employee Compensation/ Employee Hours) * Proprietor Hours, with the assumption made that the proprietor’s labor is worth as much as the employee’s. This may actually inflate labor share, as the proprietor is unlikely to be contributing as much as their average employee in terms of actual hands-on labor. This ultimately gives us the percentage of output which is received as income by those whose labor produces said output, and by subtraction (subtracting labor’s share from total output) we come to an estimate of capital’s share of output.
Labor’s share of output has been falling, both in the United States and worldwide. We see that from highs of 66%, labor’s share of output in the United States has fallen to 58%. Worldwide, both advanced and emerging market economies have seen similar decreases. Advanced economies like the United States have suffered more than emerging markets, likely because the accumulation of capital and monopolization take place as slow, deliberate forces, and an emerging market will not have had time for its capital owners to erode its laborers already abysmal share of output.
This shift in share of output away from labor is marked by both negative economic consequences, and by patently obvious unfairness. The OECD writes: “with declining labour shares, improvements in macroeconomic performance may not translate into commensurate improvements in personal incomes of households. And data shows that over time and across many countries, a higher capital share is associated with higher inequality in the personal distribution of income.”
We see that the data backs up the OECD’s first claim: that improvements in macroeconomic performance will not translate into improvements in incomes of households given our changing share of output. Since 1985, despite GDP per capita rising, real household median incomes have remained essentially stagnant. The United States has seen economic growth throughout this period, but what truly is the value of a growing economy if it has no effect on the livelihood of the people who constitute that economy?
The OECD’s second claim also finds an empirical basis in reality. We see a distinct trend line between a country’s GINI coefficient (the measure of a country’s income inequality) and a country’s labor share of output. The fact that rich capital stock owners have seen a redistribution of wealth in their direction away from laborers has resulted in an increasing GINI coefficient, and thus increased inequality. Increasing income inequality, from a purely pragmatic perspective (saving concerns of fairness for the next paragraph), is not optimal. Inequality leads to political unrest, decreased ability to consume for those further distanced from wealth, and decreased ability to invest for those left behind.
Not only is labor’s decreasing share of income resulting in household incomes stagnating and income inequality rising, but it is concerning on the level of a basic level of fairness in society. Those who must trade their labor in order to survive (i.e. the working class) have seen the majority of the shift in labor’s share come directly from them, despite worker productivity increasing during that time. Real wage growth has lagged behind labor productivity, which despite any pragmatic issues is an affront to any conception of society as fair. As workers have gotten more productive, rather than see themselves rewarded for that increased productivity, they have seen their share of the economy slowly siphoned away by the owners of capital stock and their employers. As a result of this, working class income share has fallen by about 33% from its level in 1950 despite there only being a 9.7% decrease in working class tax units (seen below).
The share of output being shifted from labor to capital is unjust. The median household has seen almost no improvement in income, despite overall economic growth. The working class’ share of the economy has been slowly eaten away at and eroded for too long. The alienation of labor from both growth in their economy and increases in their productivity will continue to manifest itself throughout the world unless the relative share of output sees a radical shift back toward labor.