Workers get a little more of the income pie

(Bloomberg View) – Good news! Labor's share of national income, which has been declining since the early 1990s, and which took a big hit in the 2008 recession, has been rising for two years.

Here's a picture of total compensation as a percentage of national income since 1990 (click on the charts to enlarge them):

This is great for workers, of course. It may also come as a slight relief for economists, whose standard models of the macroeconomy have long assumed that labor's take is a constant fraction of output. The quarter-century-long decline of the labor share has been making a lot of macroeconomists sweat, but if this upturn is sustained, it could restore the old conventional wisdom — in addition to taking a lot of pressure off of America's beleaguered employees.

Why is this happening? Well, part of the reason is that wages are rising. Here is a graph of real average hourly earnings during the past decade:

So why are wages rising? One obvious reason is that the labor market is tightening. The pool of surplus workers is shrinking as more people reenter the labor force and as unemployment falls.

Here's the employment-to-population ratio:

The recent rise looks pretty gentle, but part of that is due to population aging, especially with the retirement of the baby boomers. When you adjust for demographics, the employment-to-population ratio has actually recovered a lot more, and has made back most of the ground it lost in the recession.

A smaller pool of unemployed workers means that labor is in shorter supply, which increases its bargaining power. That lets workers demand higher wages, and forces companies to accept lower profit margins.

That's the simple part of the story. But there may be more at work here, because longer-term forces are also changing. The labor share didn't just decline because of the recession — it fell during the early 1990s and 2000s as well, despite an economy that was growing at a reasonable clip. Why did that happen?

One answer is globalization. The 1990s and 2000s were both eras in which U.S. labor markets were opening to the world. American workers were no longer competing only with each other, but with lower-paid workers in Indonesia, Thailand, Hungary and a lot of other countries. The really big shock came after China joined the World Trade Organization in 2001. That massive dump of labor onto global markets, just as the internet was enabling offshoring of supply chains, was a huge blow to a large number of workers — especially in high-paying manufacturing jobs — in the U.S. and other rich countries.

It's only to be expected that when you dump a whole lot of labor on global markets, but not an equivalent amount of capital, labor's share goes down. This is pretty simple supply-and-demand economics, but it's a result that also emerges from standard trade models. A number of economists have traced the recent labor-share decline, at least in part, to the advent of Chinese labor.

But that trend may now be reaching its natural end. When China joined the global trade system, first tentatively in the 1980s and '90s, and then whole hog in the 2000s, it was a very capital-poor country. Decades of communist mismanagement in the mid-20th century had left it without enough roads, vehicles, offices, housing, and factory equipment. But that has changed quite a bit — China has been on an unprecedented investment binge for the past several decades. It now has quite a lot of roads, factories, apartment towers, and offices — so many that onlookers now worry that much of it may go to waste. To call China a capital-poor country is no longer accurate.

So now that China is catching up in capital, much of the pressure may be off rich-world workers. If India or Africa starts industrializing, of course, that pressure may return, since these places also are short on capital and have an abundance of cheap labor. But for now, China's slowdown may be adjusting the balance of power between U.S. workers and their employers.

There are other long-term forces at work as well, and these are less positive. Matt Rognlie, now a professor at Northwestern, found recently that much of labor's decline is because more and more of society's wealth has been flowing to landowners. That might be the result of increased land-use restrictions, or it might be the natural outcome of economic activity becoming more geographically concentrated. Either way, if the long-term trend is land taking a rising share of national income at labor's expense, there's no telling if that trend will naturally correct itself. The recent welcome rise in the labor share could be just a temporary blip.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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