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May 18, 2020

How can governments mitigate the global decline in labor income share?

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Globally, the share of income going to labor (the “labor income share”) is declining. Growing concern over this trend in general, coupled with the fact that a disproportionate share of this decline is found among low-skilled workers, has encouraged debate about fair distribution of personal incomes. While the labor income share has decreased for low-skilled workers, this has been concurrent with an increase for high-skilled workers. Since the early 1980s, the labor income share for skilled workers in the US has shown an upward trend, which suggests that the decline in the aggregate labor income share is entirely driven by the falling labor income share for unskilled workers. Evidence based on a global input–output database also suggests that the labor income share has been increasing for high-skilled workers and declining for middle- and low-skilled workers worldwide.

Why has labor’s share of income declined among low-skilled workers but increased among the high-skilled? Labor is heterogeneous in skills and the ease of substitution between capital and labor differs across different skill levels. If capital can be substituted with unskilled labor more readily than with skilled labor, a drop in the relative price of capital would result in a larger drop in the employment of unskilled workers compared to skilled workers. This could then lead to a decline in the share of income for unskilled labor more so than for skilled labor, assuming that wages do not immediately change due to the changing composition of skills in the labor market. 

Globalization leading to a growing skill premium and an increasing complementarity between capital and skill through the advancement of technology also explains the polarization of labor income shares across the skill spectrum. A rising skill premium mainly drives the results for high-skilled workers, while participation in global value chains remains the dominant factor behind the decreasing labor income share for middle- and low-skilled workers. Higher exposure to routinization of tasks (i.e. the automation of tasks where labor can be substituted by capital to the highest degree) has also played a key role in the polarization of wages and skill premium along the skill spectrum. 

Social and economic policies have also led to reductions in the labor income share, especially for unskilled workers. A decline in union coverage explains about 12% of the decline in labor’s share of income between 1997 and 2006 in the US manufacturing sector. If unions are able to raise wages, then this can have a positive impact on the labor income share by increasing the gap between growth in real wages and labor productivity growth. The role of institutional forces becomes imperative when wage gains come at the expense of profits, because otherwise labor income share will continue to decline as the share of profit and capital income grows. Short-term policies that aim to create jobs for low-skilled workers in this transitioning phase should be implemented, alongside medium- to long-term redistributive measures to prevent losses in well-being resulting from further decline in low-skilled workers’ share of total income.

© Saumik Paul

Read Saumik Paul's full IZA World of Labor article here: Understanding the global decline in the labor income share

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