The decline in the share of wages in value added in the United States: what are the explanations? (Note)

Purpose of the article : The article aims to present recent research on the causes of the decline in the share of wages in value added in the United States.

Abstract:

• The share of wages in value added has fallen sharply in the United States since 2000, contributing to rising inequality and a sense of decline among part of the American population.
• The traditional explanations in the literature, such as technological progress biased in favor of capital or the effects of globalization, probably play a role but seem insufficient.
• Weakened competition in the goods and services market could be another important factor. This could be explained either by a relaxation of antitrust policy or by the emergence of « superstar » firms such as Amazon.
• Less competition between employers in the labor market could be an additional explanation.

While it remained stable during the second half of the^20th century, the share of wages in US GDP has fallen since the early 2000s. In private sector companies, it fell from 65% in 2000 to 57% in 2015, before rising slightly to 59% in 2018. This decline has contributed to rising inequality[i] in the United States and fueled a sense of decline among some of the American working class.

Since 2001, the average real hourly wage has increased by only 15%, while apparent hourly labor productivity has gained almost 40% (see Figure 2). This phenomenon is not without political consequences. The rise in inequality and the economic and social problems of the American working class could be one of the key issues in the 2020 US presidential election and are already major themes in the Democratic primaries.

Two theories have often been put forward to explain this decline. American workers, particularly unskilled workers, are said to be victims of competition from either robots or emerging countries, notably China. Numerous studies have examined these two causes without reaching a consensus. A third theory has recently entered the debate. One of the root causes of the phenomenon could be the increase in corporate profit margins, due to a weakening of competition in many sectors of the US economy.

I) Traditional explanations

I.A. Robots

Economic theory offers several explanations for the decline in labor compensation relative to capital. The first is technological change. New techniques are emerging that allow capital to replace labor, reducing the demand for labor, wages, and the wage share. In other words, the wage share is declining because workers are being replaced by robots. A recent study by Acemoglu and Restrepo (2019) supports this idea. The US regions and industries most affected by automation have experienced lower wage and employment growth than others. However, one question remains unanswered. Robotization affects many advanced economies. However, while the decline in the wage share over the past few decades is not limited to the United States, it is the only country where it cannot be explained by the rise in real estate rents, as suggested by two recent studies by Gutierrez and Piton (2019) and Cette, Koehl, and Philippon (2019). Indeed, some non-financial companies are real estate companies that rent out offices or housing. The share of capital in the added value of these companies is close to 100%. When their weight in total added value increases, the share of wages automatically decreases. Such an increase can be observed in many eurozone countries. It would be sufficient to explain the shift in the wage/profit distribution to the detriment of wages. Conversely, this effect would only contribute marginally in the case of the United States. Can robotization really have caused a decline in the wage share in the United States but not in Europe?

I.B. The « China shock »

Another explanation for the distortion of income distribution to the detriment of labor involves international trade. When a country with a large labor force but little capital opens up to a country with a much higher capital/labor ratio, this puts downward pressure on labor income in the latter country. The relationship between China and the United States could correspond to this scenario. In fact, the decline in the wage share in the United States coincides with China’s accession to the World Trade Organization (WTO) in 2001, an event that Autor, Dorn, and Hanson (2013) have called the « China Shock. » Autor, Dorn, and Hanson showed that regions most exposed to Chinese imports have higher unemployment rates and lower wages than less exposed regions. However, there is no real consensus on the issue. While other studies, such as that by Ebenstein et al. (2015), have confirmed negative effects for regions most sensitive to international competition, the effects are no longer significant when exposure is measured at the industry level. Other more recent studies, such as those by Feenstra et al. (2017) or Rothwell (2017), show no negative effect of exposure to imports on wages[iii]. These uncertain results suggest that other explanations should be explored, such as looking at the evolution of competition in the United States.

II) Increasingly imperfect competition

II.A … in the goods and services market

Weakening competition is another avenue explored in the literature. Within the US economy, many markets are characterized by increasingly less competitive functioning. Corporate margins are higher, reducing the share remaining for employees. De Loecker and Eeckhout (2017) show that, on average, the margins of companies listed on financial markets have risen from 18% above the marginal cost of production[iv] in 1980 to 67% today[v]. Autor et al. (2017) show that the decline in labor’s share of value added is greatest in sectors where concentration has increased the most. This growing concentration would also explain[vi] the weakness of US investment despite high profits and low capital costs, as suggested by Philippon and Gutierrez (2016).

While many researchers agree that the US economy has become less competitive, there is still disagreement about the reasons for this and the possible policy solutions. Autor et al. (2017) emphasize the role of « superstar » firms such as Amazon and Google. Thanks to higher productivity gains than their competitors, they have achieved positions that are difficult to challenge and can thus enjoy high margins. If this theory proves to be correct, the problem could prove more complex to solve. Stronger antitrust policies could certainly reduce concentration and allow a return to more reasonable profit margins. However, they risk weakening the productivity of the economy as a whole by preventing the most efficient firms from expanding. Philippon and Gutierrez (2017) offer another explanation. They show that the sectors that experienced the strongest concentration in the 2000s are not those that saw the strongest productivity gains. This concentration is linked to a relaxation of competition policy in the United States, and the solution would be to return to a stricter enforcement of antitrust laws.

II.B … and on the labor market

The bargaining power of firms vis-à-vis their workers can also affect the distribution of value added between profits and wages. This bargaining power depends on many parameters, such as the unemployment rate, institutional arrangements in the labor market, and the degree of competition among employers to attract workers. It is this last point that has recently attracted the attention of economists and seems particularly relevant to the US economy. The intuition is as follows. Workers, especially unskilled workers, are not necessarily very mobile geographically. They are dependent on a local labor market in which a small number of companies, such as hypermarket chains or fast food chains, may account for a very high proportion of jobs. These employers thus have strong market power and can impose lower wages than would prevail in a competitive market. A recent working paper by Azar, Marinescu, and Steinbaum (2017) attempted to measure this phenomenon and its impact on wages more precisely. The study suggests significant effects. The wage offered may be 20% lower in a local market dominated by a few companies than in a market characterized by a wide variety of employers.

Conclusion

Economists often refer to the phenomena they are trying to understand as puzzles to be solved. The puzzle of the decline in the wage share in the United States has not yet been solved, although increasingly limited competition in certain markets seems to be one of the most relevant explanations.

Will this trend continue? Low US unemployment could force companies to pass on productivity gains to wages. In fact, the wage share has been rising since 2015. However, it remains 6 points below its previous peak, just before the tech bubble burst. Without addressing the structural causes, a return to historical values seems unlikely.

Bibliography

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https://www.piie.com/blogs/trade-investment-policy-watch/has-global-trade-fueled-us-wage-inequality-survey-experts