Thursday, July 5, 2012

Wages and GNI

From the latest round of NBER working papers (abstract):

Declining Labor Shares and the Global Rise of Corporate Savings
Loukas Karabarbounis, Brent Neiman

We document a 5 percentage point decline in the share of global corporate income paid to labor from the mid-1970s to the late 2000s. Increased dividend payments did not absorb all of the resulting increase in profits, and therefore, the supply of corporate savings increased by over 20 percentage points as a share of total global savings. These trends were stronger in countries experiencing greater declines in the relative price of investment goods. We develop a model featuring CES production and imperfections in the flow of funds between households and corporations. These two departures from the standard neoclassical model imply that the labor share fluctuates and the sectoral composition of savings affects macroeconomic allocations. We calibrate the shape of the production function and the capital market imperfections to match the cross-sectional variation in the two trends. In response to the observed global decline in investment prices, our model generates more than half of the observed changes in labor shares and corporate savings. The non-unitary elasticity of substitution between capital and labor interacts with imperfections in the capital market to jointly shape the economy’s dynamics.

I’ve heard from more than a few sources regarding the declining share of household income in national income, but this is the first paper I’ve come across to do a cross-country, multi-year study to confirm it as well as tie it in with a corresponding increase in corporate savings. Moreover, the authors have modelled at least one source of why it happened – declining prices of investment goods leading to a substitution of labour for capital.

You might not want to read through the math (I didn’t), but the database the authors came up with is worth the price of admission alone – the charts begin on page 36, and are pretty self-explanatory. There’s also an online appendix available covering the data in the paper and can be downloaded through the link below – it has even more charts to ponder over.

Question: Why is all this important?

If labour’s share of income is falling, that implies that private consumption can only be maintained by lower savings or equivalently through borrowing. In short this isn’t a sustainable trend. It wouldn’t be so bad if excess corporate savings (=undistributed profits) were actually divvied up to households via dividends or capital repayments, which would help maintain household income shares.  But that isn’t really happening. Higher corporate investment is all well and good, but it won’t matter at the end of the day if there’s nobody to consume the goods that are then produced.

There’s more than one force at work here, not just the relative prices of investment goods, but also I think a decline in trade union power and a strong tie-in with income and wealth inequality. But looking at and implementing remedial measures isn’t going to be an easy.

Technical Notes:


  1. Hisham,

    Great article find. Might have a bit of contention with your statement:

    "If labour’s share of income is falling, that implies that private consumption can only be maintained by lower savings or equivalently through borrowing. In short this isn’t a sustainable trend."

    It implies that this trend will continue indefinitely. I'm not (totally) disagreeing with you, I think I'm looking at it from a structuralist perspective.

    In the past few decades, labour markets have been opened up and cross-border labour movements have been eased (and include the promotion of gender rights), a large amount of untapped labour which was previously inconvenient to employ was suddenly employable ~ case in point are the advanced economies' reaction to cheap foreign labour stealing jobs. This would cause the distribution of the returns to labour and returns to capital to become lopsided.

    But once the scarcity (or the perception of) kicks in ~ wages and profits should equalize, because really, I don't see why they shouldn't. It's just our dumb luck that we are workers born in this generation, I guess :)

    1. Sorry, that should be...

      "the scarcity of labour"

  2. I think this will explain a lot of things regarding inequality between the Bumis & Non Bumis.
    Household Income is only 50% of the story.The real divergence is via OS/Corporate Income.The growth of GNI far outstrips wages growth.And at Corp Income level,the ratio between Bumi & non Bumis have stagnated.
    Affirmative action still required and wages is a good first step.But more need to be done.But please please..not direct nego projects and APs.
    My tuppence.

  3. @Jason,

    I don't think it would be totally necessary for the trends to continue for countries to get into trouble. In some ways, the Great Recession probably represents the floor of where these trends are going. You've got a good point about the potential reversal when cheap labour suddenly isn't so cheap anymore, like what's happening in China. But I do think that it's not quite as simple as that and some structural changes need to be implemented to help things along.

    @anon 5.48

    Actually I don't believe it does (see this post). While the gap still exists, it has been narrowing rapidly for the last ten years despite little change in Bumi corporate ownership.

    The wage/corporate income gap is really across the board and affects all Malaysians, not just Bumis.