Labor and Capital in the Global Economy, Winter 2017, Democracy Journal, by Kimberly Clausing
Read the accompanying article (Labor and Capital in the Global Economy, Winter 2017, Democracy Journal, by Kimberly Clausing) and answer the following questions.
It is noted that “Economists focusing on the corporate sector have found that the labor share of income declined by 8 percentage points over the period 1980-2012, from 65 to 57 percent.”
a. According to the article, what are the major causes of this decline in the labor share of income? Describe each briefly.
b. Some scholars argue that this characterization is not valid, and it is impossible to verify such a decline. What are the reasons that scholars provide to invalidate such a trend?
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FEATURES
Labor and Capital in the
Global Economy
How three decades of technological change, globalization, and government policy made
workers more at the mercy of concentrated capital.
BY K IMBE R LY C L AU S I N G F ROM WI N T E R 2 0 1 7 , N O. 4 3 – 1 7 M I N R E AD
TAGGE D CAPI TA L ISM E CONOMY I N EQUALITY LABOR POLI T IC S TAXE S
T E CHNOLOGY
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O
Puck Magazine, February 7, 1883.
This essay is part of a series published with the support of the Washington Center for Equitable
Growth.
ver the past 35 years, the economy has been transformed by technological
change. The computing revolution and the rise of the Internet have changed
the nature of product competition, reduced communication costs dramatically, and
allowed the digitization and codification of processes. These changes have affected
the returns to different types of labor, the role of labor itself, and the nature of
bargaining between workers and companies.
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Accompanying this technological change and augmented by it, globalization has
proceeded apace. Capital mobility across borders has continued to increase, both in
terms of portfolio investments that cross borders and in terms of the reach of
multinational corporations. International trade in goods and services has continued
to expand, fueled by decreases in information costs, technological changes, and
greater policy openness to trade in many countries. Migration, while more limited by
national barriers, has also had an important impact in many places over this time
period.
Over this period of technological change and globalization, the role of labor and
capital has also changed in important ways throughout the global economy. A
generation ago, students of economics were often taught that the labor share and
capital share of all income generated in the economy should be expected to be
roughly constant over long periods of time, with about 70 percent of national income
accruing to labor and 30 percent to capital. Labor and capital are both inputs into the
production process, but the income received by workers and capital-owners likely
accrues to different economic classes of people, and so this constancy was reassuring
to those who worry about workers’ evolving standards of living.
However, several different sources of U.S. government data indicate that this
constancy has broken down in recent decades.
Income concentration creates disproportionate power
for the affluent, who hire lobbyists to influence policy.
Researchers have confirmed this decline across countries, using careful methods and
controlling for other influences that could affect these trends. Economists focusing
on the corporate sector have found that the labor share of income declined by 8
percentage points over the period 1980-2012, from 65 to 57 percent. This
phenomenon is not a distinctly U.S. trend, but rather one that has affected most
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economies, regardless of their initial income level. A recent estimate suggests that the
labor share in G20 countries has fallen at a pace of 0.3 percentage points per year
between the late 1980s and the late 2000s, and several independent analyses have
confirmed similar trends. Throughout the world, owners of capital are receiving a
greater share of national income, so growth in national income is no longer sufficient
to ensure increasing worker living standards for labor as a whole.
These facts are startling, but at least two caveats are worth bearing in mind. First, for
many types of income, it may be futile to separate labor and capital income. For
example, many of those in the top of the income distribution have tremendous wealth
that has been generated from streams of entrepreneurial income with both labor and
capital elements. For example, Mark Zuckerberg’s wealth likely represents some
combination of returns to his labor, his “human capital” (or knowledge), his risktaking,
and his ownership of capital (servers, office space, etc.) that have been
invested in Facebook. Second, the labor share alone is not a measure of inequality.
While capital income is far more concentrated than labor income, the level of
inequality depends on the distribution of labor income, the distribution of capital
income, and the labor share. In the United States, recent trends of increased income
inequality involve all three elements.
Even so, the declining labor share is problematic because it is occurring in a context
of rising income inequality and stagnant wage growth for many workers. In the
United States, all data sources indicate increases in income inequality in recent
decades, and the more capital income is included in the data source, the greater the
increase. Treasury data indicate that the top 5 percent of tax units have increased
their share of national income by 13 percentage points, from 24 percent to 37 percent,
over the period 1986 to 2012. Dividends and capital gains income are particularly
concentrated, with the top 5 percent of tax units reporting 68 percent of dividend
income and 87 percent of long-term capital gains in 2012.
The problem of wage stagnation is widely recognized, and it has been particularly
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challenging in the period surrounding the financial crisis and the Great Recession
(although the past few years have seen some improvements in the United States). For
example, a recent report by the McKinsey Global Institute indicates that two-thirds
of households in 25 advanced economies experienced flat or falling incomes between
2005 and 2014. This occurred during a period when aggregate economic growth
remained positive, illustrating the importance of income distribution in determining
economy-wide income patterns.
What Are the Consequences?
Such troubling trends in labor market outcomes have potentially grave consequences
for society. Stagnant incomes are harmful in times of weak aggregate demand, since
income gains that are concentrated at the top are less likely to fuel consumption and
aggregate demand. But beyond that impact, increased inequality amidst wage
stagnation creates social tension and discontent. When workers’ wages fall short of
expectations, and there are large cohorts of workers who are not as well off as their
parents, people are more likely to turn to populist solutions to express their
dissatisfaction. Indeed, the rise of populist candidates like Bernie Sanders and Donald
Trump are testament to the depth of dissatisfaction, even if some of the policy
solutions on offer are infeasible, misdirected, or even harmful. The U.S. Congress
continues its trend of ever-increasing polarization and dysfunction, and political
polarization extends beyond the United States as both far-left and far-right parties
are ascendant through Europe.
Concentration of incomes also creates disproportionate political power for affluent
groups, who are able to hire lobbyists to influence the policy process as well as
lawyers and accountants to best work around existing policies. Affluent groups also
enjoy greater access to policymakers by frequenting the same elite institutions and
circles. There are also important implications for the way the government is funded.
The ideal progressivity of our tax system is affected by the fact that so much of the
recent gains in national income have accrued to those at the top of the income
distribution. Since most of the federal tax burden falls on labor income through the
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income and payroll taxes, we also rely on a smaller tax base as the share of labor
income shrinks. These policy implications are discussed in more detail below.
Causes of Labor’s Decline
Six explanations have been offered for the declining labor share. First, the computing
revolution has substantially lowered the price of investment goods (the plant,
machinery, and equipment that make production possible). This has been a
worldwide phenomenon. If companies respond to the declining price of investment
goods by disproportionately increasing their use in production, then the capital share
of income will rise. For example, as computing power becomes cheaper, companies
may replace workers that used to perform data entry work with machines. A related
explanation is that technological progress has been capital-augmenting. In this
explanation, computing also plays a role, by increasing the productivity of capital
investments. So capital investments are not only less expensive, but also more
productive. In this example, firms increase their demand for computers, because
computers process more data than ever before, and this also displaces demand for
manual data entry by employees. Overall, the demand for capital increases, raising the
capital share of income.
Second, international trade and international capital mobility also play a role in these
developments. In high-income countries, increased competition from countries with
large, inexpensive labor forces may lower wages and reduce the labor share of
income. While many studies find that international trade is not the dominant
influence on labor market outcomes of rich countries, there is still evidence that it is
important, and there are relationships between international trade and technological
change that are difficult to disentangle. For example, competition from low-wage
countries may accelerate the pace of technological innovation in rich countries, as
they compete through innovations that economize on labor. To the extent that the
United States produces the same products as those in low-wage countries, it is often
by producing them with far more capital-intensive processes. Agricultural goods are
made with highly capital-intensive methods that rely on computer-guided farm
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machinery and technological sophistication in fertilizers and seeds. Shoes are made
in the United States, but in highly mechanized factories that bear little resemblance
to their less-developed country counterparts.
This raises the question of why the labor share is also observed to be declining in
many less-developed countries. One possible explanation is that international trade
increases the demand for high-skilled workers and capital in all economies, due in
part to the disintegration of the production process. Products (or steps in the
production process) that appear to be labor-intensive from the perspective of rich
countries may actually be capital-intensive from the perspective of poor countries
that are less well-endowed with capital. Thus, the growth of international trade may
increase the demand for high-skilled labor and capital in both types of countries.
Third, the greater mobility of capital may reduce workers’ bargaining power more
generally, as companies move abroad (or merely threaten to), restraining wage
growth. Unionization rates have been declining in many countries, and the
unionization rate in the United States has declined from 31 percent in 1960 to 11
percent today. These numbers mask an even greater fall in private-sector
unionization rates, now at 7 percent. Reductions in unionization rates have occurred
across developed countries; the average unionization rate for workers in OECD
countries was 35 percent in 1960 and 17 percent in 2014. Other institutional
considerations may also play a role in the declining labor share, including labor
market regulations, minimum wage laws, and other features of the safety net.
Fourth, the so-called “Superstar Effect” attempts to explain why those at the top of
the income distribution reap outsized rewards. Recent analyses have also emphasized
how both globalization and technical change can affect the returns at the very top of
the income distribution by boosting the real and relative earnings of “superstars” and
capital. The combination of larger world markets and the ease of digitizing and
distributing information creates outsized returns to the most productive talents in
society relative to others that merely face increased competition.
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As an example, the best movie stars and athletes earn premium returns, since their
talents are now accessible to their fans throughout the world, who can watch videos
and sporting events remotely. This increases the size of the entertainment sector, but
the actors and athletes that are slightly less talented may earn less, since there are
increased costs associated with paying those that own the intellectual property of the
superstars. These owners include the stars themselves as well as those investors and
producers that control the rights to the worldwide distribution of their products.
Fifth, rents—that is, the excess profits that arise from entrepreneurial success—play
an important role in this story of the declining labor share. Much of the inequality in
both labor and capital income, as well as the explanation for the rising capital share,
may be due to what Victor Fleischer terms “alpha” income, or income from
entrepreneurship and the risky returns to human ingenuity. Such income may take
the form of founder’s stock, carried interest and partnership equity, or simply
outsized salaries.
Alongside entrepreneurial rents, there is substantial evidence of an increased
importance of market power and corporate rents for large corporations. Researchers
show that declining labor shares have been associated with a large, pervasive increase
in corporate savings. Over the previous 30 years, corporate savings have increased
corporations’ share of total global savings by about 20 percentage points. In the
United States, Treasury economists calculate that the fraction of the corporate tax
base that consists of these excess profits averaged 60 percent from 1992 to 2002, but
has since increased to about 75 percent over the period 2003-2013.
Globalization and technology have transformed the
economy, but curbing either is likely to be harmful.
Indeed, the recent era has been marked by growing firm concentration, with large
firms earning the lion’s share of profits. McKinsey Global Institute calculates that the
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top 10 percent of the world’s public companies earn 80 percent of the profits, and
firms with more than $1 billion in revenues account for 60 percent of all global
revenues and 65 percent of market capitalization. In the United States, corporate
profits in recent years are higher as a share of GDP than they have been at any point
in the last 50 years, either in before-tax or after-tax terms. Since 1980, corporate
profits after tax have increased 4 percentage points, from about 6 percent of GDP to
about 10 percent.
Sixth and last, tax policy is a factor in labor’s declining share of income. Thomas
Piketty, Emmanuel Saez, and their co-authors note that there is a tight relationship
between increases in the share at the top of the income distribution and the evolution
of tax policy. Over the past century, the top shares of the income distribution have
followed a “U” pattern in several countries, including the United States, Australia,
Canada, and the United Kingdom, where the share of income earned by the top 1
percent declined steadily until the 1970s, and then increased since the 1980s. At the
same time, top marginal income tax rates moved in the opposite pattern, increasing in
the first half of the twentieth century, and declining steeply since 1980.
One possible explanation for this correlation is that top incomes are more likely to be
hidden in order to avoid taxation when tax rates are high, so high incomes are merely
more visible in the presence of lower tax rates. A second explanation, and the one
favored by these authors, is that changes in top marginal tax rates change the
bargaining process between workers and managers. When top tax rates decline, this
increases the incentive for highly compensated earners to bargain aggressively for
pay, increasing incomes at the top of the income distribution. Simply put, high tax
rates serve as a break on “surplus extraction” by high-income earners, but this break
is relaxed just as the world economy changes in a way that increases demand for
capital, the most highly skilled, and superstars, so compensation at the top surges
accordingly. Still, the correspondence between tax rate cuts and surging income
inequality could also reflect evolving social norms, or it could simply be a
coincidence.
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What Should Be Done?
As in medicine, perhaps the most important rule is simply to do no harm. While
globalization and technological growth have played important roles in these dramatic
changes in the economy, curbing trade or technology is likely to cause more harm
than good.
Trade, like computers, creates both winners and losers. Unfortunately, the workers
who would have made the goods now made by foreign workers (or domestic robots)
are harmed by it. But workers in export industries benefit, and consumers benefit
from price reductions on virtually every product they consume. Increased foreign
competition prevents domestic firms from wielding undue market power. Economic
growth abroad creates more stable societies and alleviates world poverty. Close,
mutually beneficial economic ties between countries build peaceful relationships and
reduce needless antagonism among nations. Addressing global policy problems like
climate change will require an international community that is more interested in
building bridges than walls.
Indeed, the country as a whole benefits from trade. When the international
community wants to punish countries for wrongdoing, it sanctions them by reducing
their ability to engage in international trade, often greatly harming their populations.
Protectionism is like sanctioning ourselves, a form of economic self-harm. We should
no more throw away the benefits from trade than throw away our computers.
Luckily, there are far better ways to address these troubling labor market
developments. Targeted income redistribution, such as expansion of the earnedincome
tax credit, coupled with larger tax contributions from those that have most
benefited from the economic growth of the previous decades, would be a sensible
way to help U.S. workers. Investing in infrastructure and education would help
buttress worker productivity and living standards. Labor laws and regulations can
allow a flexible and dynamic economy, while also aiming to protect worker interests
and buttress their hand in bargaining.
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The Role of Tax Policy
The tax system is our most important instrument for affecting the distribution of
income, and reforms of tax policy can help make sure that changes that benefit the
whole economy, such as international trade and technological progress, also benefit
all those within the economy. Such tax policy changes will involve smaller gains in
after-tax income for those at the top of the income distribution, coupled by
reductions in tax burdens for those whose incomes are stagnating.
At present, there are aspects of our tax system that work well and aspects of the tax
system that are in desperate need of repair. On the labor income side, relatively small
tweaks can help address these labor market trends, including a more generous
earned-income tax credit as well as middle-class tax cuts.
Perhaps most problematic is our taxation of capital income. Here we have a weak and
porous corporate tax system, coupled with little or no capital taxation at the level of
the individual taxpayer. Capital income is highly tax-preferred at the individual level,
taxed at top rates that are about half that of labor income, if it is taxed at all, which it
often isn’t. Recent research suggests that as little as one quarter of U.S. corporate
equity income is taxable through the income-tax system. Most capital income grows
tax-free in tax-preferred retirement accounts, pensions, 529 accounts, or in nonprofit
endowments.
This leaves the corporate tax as the dominant tax on capital income. Yet the U.S.
corporate tax collects relatively little revenue compared to GDP, compared with peer
nations, in spite of the fact that U.S. corporate profits have been increasing rapidly
and stand at historically high levels. Several factors are responsible for this
disconnect: Our tax base is narrow, there is a large tax preference for non-corporate
income, and multinational corporations have become increasingly adept at shifting
profits offshore, where they accumulate at very low tax rates.
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These problems, as well as proposed policy solutions, are discussed in far more detail
in my recent report for the Washington Center for Equitable Growth on
“Strengthening the Indispensible U.S. Corporate Tax.” Protecting the corporate tax
base is important for many reasons: Capital taxation has an important role in an
efficient tax system, it is difficult to crisply distinguish capital and labor income for
purposes of taxation, and capital income is increasingly taking the form of rents, or
excess profits. Importantly, capital income is far more concentrated than labor
income, and the corporate tax is likely to burden capital or shareholders far more
than it burdens workers. This stands in contrast to most other federal taxes, where
the burden falls entirely on labor.
Several key reforms would strengthen our corporate tax system. Helpful incremental
steps would include a minimum tax of foreign income earned in low-tax countries,
“earnings-stripping” rules that would make it more difficult to shift profits to low-tax
countries, and anti-inversion rules that would limit the ability of firms to move their
headquarters to low-tax jurisdictions for tax purposes. More fundamental reforms
such as worldwide consolidation of U.S. corporate tax returns would be even more
effective.
These corporate tax reforms should be coupled with changes that harmonize the
treatment of different types of income, in order to minimize tax-gaming and to make
our tax system more efficient. Debt-financed and equity-financed investments should
be treated more evenly, corporate and non-corporate business income should be
taxed more similarly, and capital and labor income should face the same tax rate. In
addition, capital income taxation should be buttressed by fixing loopholes in estate
taxation and eliminating the step-up in basis at death, which allows many capital
gains to escape taxation entirely, disproportionately benefiting those at the very top
of the income distribution receiving inherited wealth. Policymakers should also
consider limiting the size of tax-free retirement accounts.
These tax reforms would update our tax system to make it more suited to the modern
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global economy, making sure that economic growth benefits most households. Such
tax reforms address the troubling side of the changes in our economy over the
previous 35 years, the diminishing share of labor income, and increasing income
inequality.
R E AD MORE A B O U T CAPI TA L ISM E CONOMY I N EQUALITY LABOR POLI T IC S
TAXE S T E CHNOLOGY
K IMBE R LY C L AU S I N G is the Thormund A. Miller and Walter Mintz Professor of
Economics at Reed College.
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