by Robert Z. Lawrence, voxeu.org
Appeared originally at Voxeu.org
The US debate over income inequality in the 1980s and 1990s focused on the growing disparity between the earnings of the skilled, the unskilled and the super-rich. After the global crash, the decline in labour’s share of national income has been added to these concerns.
This column presents an alternative explanation for this decline, arguing that limited substitution possibilities between capital and labour combined with the acceleration in the pace of labour-augmenting technical change raises the effective labour-capital ratio. The policy implications of this alternative explanation are profoundly different from those currently circulating.
The US debate over income inequality in the 1980s and 1990s focused on the growing disparity between the earnings of skilled and unskilled workers and the earnings of the super-rich. Since 2000 and especially after 2007, however, the decline in labour’s share of national income (See Fig 1) has been added to these concerns.
There are several plausible reasons for this development — globalisation, automation, weak bargaining power of labour, political capture, higher markups — but the natural starting point for explaining factor income shares is the theory of the functional distribution of income enumerated by John Hicks (1963) and Joan Robinson (1932) in the 1930s. This theory, which emphasises the ease with which capital and labour can be substituted, points to a combination of weak investment and technical change that has made workers more productive as the explanation for recent declines in labour’s share in income.
Figure 1. Share of labour compensation in US national income 1969-2014
Source: BEA National Income Accounts Table 1.12.
Capital’s income equals the rate of return on capital (r) times the quantity of capital (K). Similarly, labour’s income equals the wage rate (w) times the amount of labour employed (L). Thus the ratio of factor incomes, (rK / wl), can be expressed as the product of relative factor prices (r/w) and relative factor quantities (K/L).
