Report

Teaser, summary, work performed and final results

Periodic Reporting for period 1 - GaSLS (The Role of Global and Sectoral Factors in Labour Share Fluctuations)

Teaser

Over the last three decades, the labour’s share of income, a measure showing the distribution of income between profits and wages, has been falling. This observation is at odds with Kaldor’s (1961) most influential stylized fact for macroeconomic modelling: the long run...

Summary

Over the last three decades, the labour’s share of income, a measure showing the distribution of income between profits and wages, has been falling. This observation is at odds with Kaldor’s (1961) most influential stylized fact for macroeconomic modelling: the long run stability of the labour shares. Following Kaldor’s stylized fact, social scientists had largely neglected the topic until the early 1990s and economic research has only lately made a substantial comeback. The observed fall has attracted the attention of economists, policymakers and the media. This is because the fluctuations of the labour share have important effects on the business cycle, economic growth, inequality and macroeconomic policies.
The extent to which this matters to society was demonstrated by protests such as ‘Occupy Wall Street’, a movement against social and economic inequality worldwide. More recently, Thomas Piketty’s book, ‘Capital in the Twenty-First Century’, on the back of unprecedented sales, was described by the Economist, in 2014, as “the book that caught the world by storm”. As Piketty states on p.2: “the distribution of wealth is of interest to everyone”. These are real world examples suggesting that inequality-related research is a priority for our society. Moreover, The Societal Challenge of the Horizon 2020 programme has identified that one crucial challenge for the future of Europe is to reduce inequalities and social exclusions in the continent. In 2014, the G20 leaders recognized the need to “support development and inclusive growth, and help to reduce inequality and poverty”.
The fall in the labour share of most advanced economies since the 1980s has been associated with income inequality. Research by the Federal Reserve Bank of Saint Louis has demonstrated that the larger the decline in the labour share the more inequality increased in advanced economies. Therefore, examining the sources of the decline in the workers’ share of income is crucial to improve our understanding of macroeconomic dynamics and the policy implications drawn from macroeconomic models. The aim of this project is to enhancer understanding of what drives the labour share from a multi-country, multi-sector, and firm-level perspective, by accounting for differences in investment opportunities arising from financial obstacles. This project places finance, and in particular, the role of financial constraints at the heart of the labour share literature.

Work performed

The Marie Sklodowska Curie fellow started the project with a secondment at the OECD. During this time period, the fellow firstly worked on creating an indicator of labour market resilience using advanced econometric techniques. The results contributed towards the new OECD Jobs Strategy released in December 2018. In particular, the indicator measured the average increase in the unemployment rate over the three years following an adverse shock to GDP of 1%, with a high value implying a low resilience. The main result is that the more resilient the labour market of a given country the better its performance across all dimensions of the labour market.
Secondly, the fellow explored the link between firm-level financial constraints, capital-labour substitution, and the labour share. The research focused on examining whether firms which are highly dependent on external finance are unable to take advantage of declines in the relative price of investment goods to substitute capital for labour due to external financing constraints. Using the ORBIS dataset, the results provided evidence that this is indeed the case. A box was drafted that appeared in a paper for Working Party No.1 of the Economic Policy Committee of the OECD.
Upon her return at the Bank of Greece, the fellow focused on assessing the still under-explored channel through which financial constraints hinder the substitution of capital for labour, in response to a decline in relative investment prices. In particular, measuring the real cost of capital requires taking into account not only the price of investment goods but also the financial frictions firms are facing, as the latter may reduce the capacity of a firm to take advantage of declines in investment prices in order to substitute capital for labour. This project used data for up to 26 OECD countries over the 1995-2014 period. The results suggest that: (i) there has been a global decline in the labour share that coincides with declines in the relative price of investment goods and this decline has been heterogeneous across countries with different levels of financial constraints; (ii) industries highly dependent on external finance face a lower decline in the labour share following a drop in the relative investment price than industries that are less dependent on external finance, possibly because they are more constrained in accessing funds to finance investment; (iii) industry-level investment prices affect the firm-level labour share, but those effects are larger in less financially constrained and highly productive firms.
A link to the working paper that resulted from the Marie Sklodowska Curie fellowship is available at the project’s website (see link below). Throughout the fellowship period, the fellow participated or was invited to a number of international workshops and conferences. The results were presented, and therefore disseminated, to both the academic and the policy-making world.

Final results

During the course of the Marie Sklodowska Curie fellowship, substantial progress has been made in identifying a significant channel that explains the heterogeneous decline of the labour share across countries, industries and firms. It fills a gap in the literature by exploring the link between labour share changes and declines in the relative price of investment goods, taking into account differences in investment opportunities that arise due to financing obstacles. The key results of the project point towards the existence of a systematic relationship between financial constraints and labour share developments, implying that technical change and innovations can often be obstructed or abandoned due to limited financial resources. Therefore, this project contributes to the debate on the global decline of the labour share by providing a solid empirical analysis that calls for further research on the role of finance.
The end of the fellowship was marked by the organization of a workshop on “Labor Income Share Developments: Drivers and Policy Implications”. There was a good international representation from both the academic and the policy-making world (a link to the workshop’s programme is available at the project’s website, see link below). This led to, not only a wide dissemination of the project’s results, but also to future collaborations that will further investigate the relevance of financial constraints for the choice of firm’s capital investments over time. The Marie Sklodowska Curie fellowship and GaSLS started the process of closing a gap in the existing literature on the drivers of labour share declines. The outcomes of this project motivate the need for further exploration of the role of financial obstacles on a firm’s technology choice.

Website & more info

More info: https://www.bankofgreece.gr/Pages/en/Publications/mariecurie.aspx.