How is income divided between labor and capital? Every dollar of income earned by U.S. households can be classified as either labor earnings — wages and other forms of compensation — or capital earnings — interest or dividend payments and rent. The split between labor and capital income informs economists’ thinking on several topics and plays a key role in debates regarding income inequality and long-run economic growth. Unfortunately, distinguishing between labor and capital income is not always an easy task.
Until recently, the division between labor and capital income had not received much attention. The reason was quite simple: Labor’s share never ventured far from 62 percent of total U.S. income for almost 50 years — through expansions, recessions, high and low inflation, and the long transition from an economy primarily based on manufacturing to one mainly centered on services. As it happened, the overall labor share remained stable as large forces pulling it in opposite directions canceled each other out — a coincidence that John Maynard Keynes famously called “a bit of a miracle.” But the new millennium marked a turning point: Labor’s share began a pronounced fall that continues today.
Why did the labor share lose its “miraculous” stability and embark on a steep decline? To investigate this shift, economists must first be sure they are measuring the labor share correctly. Could measurement problems distort our understanding of what has happened to the labor share over time? In this article, I explain the inherent challenges in measuring the labor share and introduce several alternative definitions designed to address some of the measurement problems. As we will see, the overall trend is confirmed across a wide range of definitions.
This article appeared in the Third Quarter 2015 edition of Business Review. Download and read the full issue.