Meet the Author

Margaret Jacobson |

Senior Research Analyst

Margaret Jacobson

Margaret Jacobson is a senior research analyst in the Research Department of the Federal Reserve Bank of Cleveland. Her primary interests are macroeconomics, monetary policy, banking, and financial crises.

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Meet the Author

Filippo Occhino |

Senior Research Economist

Filippo Occhino

Filippo Occhino is a senior research economist in the Research Department at the Federal Reserve Bank of Cleveland. His primary areas of interest are monetary economics and macroeconomics. His recent research has focused on the interaction between the risk of default in the corporate sector and the business cycle.

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02.03.2012

Economic Trends

Behind the Decline in Labor’s Share of Income

Margaret Jacobson and Filippo Occhino

Labor income, which includes wages, salaries, and benefits, has been declining as a share of total income earned in the U.S. Here, we look at the cyclical and long-run factors behind this development.

Labor and capital both contribute to the production of goods and services in the economy, and each gets compensated with income in return. The share of total income accruing to labor, the labor income share, is a closely watched indicator because it can affect a wide range of other important macroeconomic variables, such as income distribution, human capital accumulation, the composition of aggregate demand, and tax revenue.

For decades, the labor income share has been fluctuating around a long-run value of approximately two-thirds. More recently, however, the share has been trending down. In the nonfarm business sector, which accounts for roughly 74 percent of the output produced in the U.S. economy, the share has decreased from values around 65 percent before 1980 to the current level of 57.6 percent. This decline has accelerated during the last decade. Excluding the financial sector, the labor income share was more stable up to the year 2000, but it has been trending down since.

It is interesting to look at this decline from a different angle. When the share of income accruing to labor declines, it means that labor income grows at a lower rate than total income. In other words, the compensation that workers receive in return for their labor grows at a lower rate than the output that they contributed to producing. Another way of saying this is that workers’ compensation per hour worked—the wage rate—grows at a lower rate than the output produced per hour worked—labor productivity. In short, when labor’s share of income declines, the wage rate grows less than labor productivity. In the business sector, the gap between compensation per hour and productivity—the wage-productivity gap—remained quite stable before 1980, began widening during the 1980s and 1990s, and opened up more visibly during the last decade.

Productivity growth in the nonfarm business sector averaged 2.7 percent before 1973, then 1.4 percent during the 1974-1995 slowdown, and 2.5 percent after the 1995 acceleration. Compensation per hour lagged behind productivity during the slowdown and more so during the acceleration, when it averaged 2 percent, almost half a percentage point less than productivity.

Economists have identified three long-term factors that can explain why the wage-productivity gap has widened and the share of income accruing to labor has declined. The first is the decrease in the bargaining power of labor, due to changing labor market policies and a decline of the more unionized sectors. Another factor is increased globalization and trade openness, with the resulting migration of relatively more labor-intensive sectors from advanced economies to emerging economies. As a consequence, the sectors remaining in the advanced economies are relatively less labor-intensive, and the average share of labor income is lower. The third factor is technological change connected with improvements in information and communication technologies, which has raised the marginal productivity and return to capital relative to labor.

In addition to these long-run factors, some cyclical factors are behind the current low level of the labor income share. Over the cycle, the labor income share tends to increase during the early part of recessions, because businesses lower labor compensation less than output, and compensation per hour continues to increase even as productivity slows down. Then, after reaching a peak sometime during the recession, the labor income share tends to decrease during the rest of the recession and the early part of the recovery, as output picks up at a faster pace than labor compensation, and compensation per hour grows at a slower pace than productivity. Only later in the recovery, as the labor market tightens, does labor compensation catch up with output and productivity, and the labor income share recovers.

The current cycle has followed a similar pattern, with output initially falling more than compensation and then picking up at a faster pace. There have been some notable differences though. This time, the losses of output and compensation during the recession have been much larger, about 8 percent. It took four years for output to recover, while compensation is still 5 percent below its pre-recession peak. Productivity recently slowed down and has barely grown in the past year. Compensation per hour slowed down even more and has been roughly flat for two years. The weak labor market may be one reason why compensation is growing so slowly. The labor market needs to make further progress before we see compensation growing at rates more in line with past cycles.