Too Much Capital, or Too Little?
Some of the debate over labor's declining share has taken place within a long-standing theoretical framework based on the neoclassical models developed by John Hicks in the 1930s. Within this framework, different economists have advanced starkly different explanations for the decline of labor's share. For one school of thought, the decline reflects an abundance of capital relative to labor; for another school, the decline reflects a scarcity of capital relative to labor whose productivity has been augmented by technical change. (In this context, when economists refer to "capital," they mean equipment, machinery, and structures.)
The "abundance" and "scarcity" schools hold different views about how much the productivity — and hence the rewards — of labor and capital change as firms change their mix of capital and labor. The abundance school holds that capital and labor are highly "substitutable," which means that changes in the capital-labor mix have only modest effects on the productivity of capital relative to labor. When this is the case, capital accumulation tends to increase capital's share of income and decrease labor's share.
The scarcity school holds the opposite view — that capital and labor are not highly substitutable. When this is the case, capital accumulation increases labor's share. Conversely, capital depletion decreases labor's share.
Thomas Piketty, author of Capital in the Twenty-First Century, is a prominent adherent of the abundance view. He sees it as an inherent feature of capitalism that capital grows more rapidly than labor. In Piketty's view, this process was interrupted in the 20th century by the disruptions of the two world wars and the Great Depression, but the trend has reasserted itself in the 21st century. If capital and labor are highly substitutable, this process of capital accumulation will cause an inexorable decline in labor's share.
Loukas Karabarbounis of the University of Minnesota and Brent Neiman of the University of Chicago provided support for the abundance view in a widely cited 2014 article in the Quarterly Journal of Economics. They built an economic model in which declines in the relative price of investment goods (such as IT equipment) give firms an incentive to increase investment and ultimately operate with more capital relative to labor. Based on the assumption that capital and labor are highly substitutable, this shift increases capital's share and decreases labor's share. Estimating the model across countries and industries, they found two results consistent with their view. First, they found a high degree of substitutability between capital and labor. And second, they found that "larger labor share declines occurred in countries or industries with larger declines in their relative price of investment goods."
Workers' Shrinking Share of the Pie
Economists have advanced a wide variety of explanations for why workers' share of overall income has been going down
Those who hold the abundance view are in the minority — most mainstream economists hold the scarcity view. Robert Lawrence of Harvard University, for example, makes a case for the scarcity view in a 2015 National Bureau of Economic Research working paper. Based on his analysis of U.S. economic data, he concluded that capital has become scarce relative to a labor supply that has been augmented by technical change. Since, based on his empirical estimates, capital and labor are not very substitutable, this has caused a decline in labor's share.
Lawrence and others have also rebutted the abundance view more informally by pointing to the lack of an investment boom in the United States over the past two decades. Lawrence has noted that "the conventional wisdom is that there have been huge breakthroughs in information technology that might have been expected to lead to unusually strong investment. Yet, as we have seen, investment has been weak." According to this point of view, the process in the United States has not been one of capital accumulation per se but rather a change in the mix of technical knowledge and equipment that has augmented labor.
The majority of empirical evidence has supported the scarcity school, but the question remains open. The criterion for judging between the two sides of the debate has often come down to competing estimates of the elasticity of substitution — the degree of substitutability — between labor and capital. But this is tricky business.
"The elasticity of substitution is notoriously difficult to estimate," says Bart Hobijn of Arizona State University. "Due to measurement error and other technical issues, you are likely to find something that implies a middle ground where labor's share is constant. A further complication is that different types of investments have different elasticities of substitution."
This latter observation points to an important weakness of the many economic models that are based on a single representative firm: They cannot account for differences among firms and their production processes.
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