Is technology to blame for the decline of labour’s income share?

A well-known “ stylized fact ” in economics holds that the
distribution of income between labor (wages and salaries) and
capital (stocks and bonds) is fairly stable over time. Yet quite a
number of researchers find that the share of income going to
labor has been on the decline over the past several decades—the
most famous, of course, being Thomas Piketty in his book
“Capital in the 21 Century.”
Whether this change is as a result of changes in technology is
hotly debated in economic circles. Last week, Dylan Matthews at
Vox reviewed the research on the question of the labor share,
noting that researchers posit a variety of hypotheses, among
them the financialization of the U.S. economy, which benefits
the owners of capital over wage earners, the downward pressure
in U.S. wage brought about by globalization, the decline of labor
unions, and the growing accumulation of capital.
But one hypothesis—what Matthews calls “robots”—now garners
the most attention. Research by the University of Chicago’s
Loukas Karabarbounis and Brent Neiman finds that the decline in
the price of investment goods, such as computers or industrial
robots , has led to the decline in the labor share of income. Firms
have responded to this price decline by substituting capital for
labor, meaning firms are investing more in technology and less
in the size and remuneration of their workforces.
This result implies a high level of “elasticity of substitution,” or
the ability to substitute one type of input for another in the
making of a good or the delivery of a service. The two
researchers calculate this elasticity between capital and labor at
approximately 1.25, which is high compared to previous
estimates of the elasticity. To put this number in context, when
the elasticity is higher than 1, a decrease in the price of capital
would reduce the labor share of income. And if it’s below one,
the labor share would increase after a decrease in the price. The
authors find that the elasticity results also hold after accounting
for the depreciation of capital goods, which is important because
the rate of depreciation has accelerated in recent years.
But labor’s share of income can decline without the elasticity of
substitution being so high. Researchby economists Ezra
Oberfield of Princeton University and Devesh Raval at the Federal
Trade Commission take a different approach and find a much
smaller elasticity while still seeing a decline in labor’s share of
income. In Oberfield and Raval’s model, there are two ways for
labor’s share to decline. The first is for the price of a factor of
production (labor or capital) to decline. Karabarbounis and
Neiman’s research finds that the price of capital has declined
and that explains the decline in the labor share.
The other option is that technology has changed so much that
capital is more productive now when invested in new technology
so more firms are investing in technology at the expense of
labor. Oberfield and Raval’s research finds this second option is
more important. Whereas Karabarbounis and Neiman look at
changes in labor’s share of income across the United States to
find their elasticity of 1.25, Oberfield and Raval use data from
individual firms to estimate an elasticity for the entire economy.
They find a far lower elasticity of about 0.7.
So Oberfield and Ravel argue that what’s causing the decline in
labor’s share of income isn’t cheaper capital or more capital
accumulation but rather a technological shift toward using
capital more. What’s interesting is they say the cause is
technology, which they broadly define to include the offshoring
of jobs. For these two authors, the technology required to
offshore production is a form of capital substitution for labor in
the United States, yet they also point out their results don’t point
toward a simple offshoring story. What’s happening is quite
nuanced, they argue, involving investments in new technology
and new workers overseas.
Is this new research just a distinction without a difference? Not
at all. Our understanding of how technology is changing our
economy, the causes of rising inequality, and the proper policy
responses are all influenced by the outcomes of this kind of
research. So believe it or not, whether one economic variable is
larger or smaller than 1 has quite a bit of impact.