Since the early 1980s, the US has seen a falling labour share and slow wage growth for typical workers. Measures of corporate valuations like Tobin’s Q have risen, and measured markups have increased. And – until the current crisis – unemployment had fallen to record lows, even as inflation stayed low, suggesting a decline in the non-accelerating inflation rate of unemployment (NAIRU).
Globalisation or technological change have often been posited as causes for the falling labour share (e.g. Elsby et al. 2013, Karabarbounis and Neiman 2014, Abdih and Danninger 2017, Autor et al. 2020). But the decline in the labour share has been much more pronounced in the US than in other industrialised economies which are arguably similarly exposed to globalisation and technological change (Gutiérrez and Piton 2019). And the increases in corporate valuations and markups – as well as rising profit rates, even as the safe interest rate declines – appear to suggest that rents to capital have increased. This makes the recent evolution of the US economy difficult to explain in a perfectly competitive framework (particularly since one might have expected globalisation to have led to increased competition for US firms, and reduced profitability). These observations have rightly led many researchers to focus on country-specific, non-competitive explanations for these phenomena.
More recently, therefore, a number of papers have argued that increasing monopoly or monopsony power can explain trends in the labour share, corporate valuations, profitability, and markups (e.g. Barkai 2017, De Loecker et al. 2020, Eggertsson et al. 2019, Farhi and Gourio 2018, Gutiérrez and Philippon 2017, Philippon 2020). But while these factors have no doubt played some role, a different factor provides a more compelling explanation: the broad-based decline in worker power in the US economy.
In our recent paper, we argue that the decline in worker power – as private sector unionisation and union power fell, the real value of the minimum wage declined, shareholder activism increased, and ‘ruthless’ management tactics became widespread – redistributed income from workers to capital owners, leading to a fall in the labour share, rising corporate valuations and measured markups, and a decline in the NAIRU (Stansbury and Summers 2020). We believe this explanation, which we dub the ‘declining worker power hypothesis’, has been substantially under-emphasised in recent macroeconomic debates. Our focus on the decline in worker power as the major structural change in the US economy is in line with a long history of progressive institutionalist work in economics, political science, and sociology (as exemplified by Freeman and Medoff 1984, Levy and Temin 2007, Bivens et al. 2018, Kristal 2010, Rosenfeld 2014 and Ahlquist 2017).
In this column, we present four arguments which demonstrate that the decline in worker power is a more compelling explanation for recent macro trends than a broad-based rise in monopoly power:
1. It is not possible to identify separately a rise in monopoly power versus a fall in worker power from trends in Q, corporate profitability, and measured markups. The same trends could have been caused by either.
2. The decline in worker power over the last four decades can explain trends in the labour share and corporate valuations at both the aggregate and the industry level (and can do so better than product market concentration).
3. The decline in worker power is more consistent with another important macroeconomic trend of recent decades – the decline in the NAIRU.
4. There is a large body of direct evidence that there has been a broad-based decline in worker power in the US, while it is far from clear that there has been any broad-based rise in monopoly power.
1. Rising monopoly power and falling worker power have the same implications for the labour share, Q, corporate profitability, and measured markups
A number of papers demonstrate that rising monopoly power could successfully explain the rise in corporate valuations and Tobin’s Q, the rise in measured markups, and the increase in corporate profitability even as safe interest rates have declined (Barkai 2017, Farhi and Gourio 2018, Eggertsson et al. 2019, De Loecker et al 2020). These facts, however, can be equally well explained by the declining worker power hypothesis. Assume that many firms have some degree of monopoly power – whether arising from explicit barriers to entry, or from features like heterogeneous production technologies or short-run fixed costs – and so generate ‘pure profits’ or rents. Worker power determines the degree to which workers receive a share of these rents. In this model, an increase in monopoly (or monopsony) power would increase the firm’s pure profits, increasing the share of income going to capital, increasing corporate profitability relative to the risk-free rate, and increasing Tobin’s Q. But, a decline in worker power would look similar: as worker power declines, rents are redistributed from labour to capital owners, meaning that the labour share declines, corporate profitability rises, and Tobin’s Q rises (as the expected value of future capital income increases).
Perhaps less obviously, falling worker power and rising monopoly or monopsony power have the same implications for measured markups. Falling worker power mechanically increases the markup measures commonly used in US data (like those in Gutiérrez and Philippon 2017 or De Loecker et al. 2020) – not because underlying market power for the firm has risen, but because these markup measures rely to some extent on a comparison of revenues to costs, where the measure of costs includes labour costs. If the rents earned by labour fall, reported labour costs fall, causing measured markups to rise mechanically even though there has been no change in underlying market power. We discuss this further in the endnotes.1
2. The decline in worker power can explain trends in the labour share, Q, and corporate profitability (and can do so better than rising product market concentration)
Was the decline in worker power big enough to explain these trends in practice? We attempt to quantify the decline in labour rents over 1982-2016, using estimates of the wage premia earned by unionised workers, workers at large firms, and workers in highly paid industries. On our metric, labour rents have declined substantially: from 12% of net value added in the U.S. nonfinancial corporate sector in the early 1980s to 6% in the 2010s (Figure 1). This decline in labour rents is big enough to explain the entire decline in the labour share in the nonfinancial corporate sector (Figure 2).2,3 And this in turn can explain much of the increase in corporate valuations: Greenwald et al. (2020) find that 43% of the increase in equity values over 1989-2017 can be explained by a reallocation of rewards from workers to shareholders as the labour share declined.
Industry-level evidence also supports the declining worker power hypothesis. Industries with bigger declines in labour rents saw bigger declines in their labour share and bigger increases in Q and corporate profitability. In horserace regressions, declining labour rents have substantially more explanatory power than rising product market concentration. And, much of the decline in the U.S. labour share occurred in manufacturing, which (given increasing globalization) is not an industry where a large rise in monopoly power seems likely to have occurred.
Figure 1 The decline in labour rents, US nonfinancial corporate sector, 1982-2016
Figure 2 Labour share and labour rent share, US nonfinancial corporate sector, 1982-2016
3. The decline in worker power is consistent with the decline in the NAIRU (more so than rising monopoly power)
Most theoretical models would predict that a fall in worker power would lead to a fall in the NAIRU, as firms’ cost of hiring declines, or as ‘wait unemployment’ falls (e.g. Hall 1975, Mortensen and Pissarides 1999, Alvarez and Shimer 2011).4 Consistent with this, states and industries with larger falls in labour rents over 1984-2016 had larger falls in unemployment. Roughly extrapolating from our state-level estimates, we suggest that the fall in labour rents since the 1980s might have predicted a three quarters of a percentage point fall in the NAIRU. Similarly, Figura and Ratner (2015) estimate that the decline in the labour share could have contributed two-thirds of a percentage point to the decline in the NAIRU.5
While a theory does not need to be able to explain all macro trends to be compelling, we do see the ability to explain the falling NAIRU as a strength of the declining worker power hypothesis: in contrast, there is no particular reason to expect rising monopoly power to cause a decline in the NAIRU (and indeed many models predict the opposite).6
4. There is a large body of evidence of a broad-based decline in worker power (while it is far from clear that there has been a broad-based rise in monopoly power)
A large body of work documents a broad-based decline in worker power in the US over recent decades (e.g. Levy and Temin 2007, Rosenfeld 2014, Ahlquist 2017, Farber et al. 2018). The private sector unionisation rate fell from over one third at its peak in the 1950s to 6% today, reducing wages both directly and indirectly (as unions tended to have positive spillovers on non-union pay). This decline was driven both by institutional factors – weakened labour law and its enforcement, the expansion of right-to-work – and economic factors like import competition and deregulation, which increased the elasticity of demand for labour.7 In addition, rent-sharing power for non-union workers declined as shareholder power and activism increased, and more ‘ruthless’ corporate management tactics became widespread. These pressures resulted in wage reductions within firms,8 reductions in the pay premia earned by workers at large firms or in highly profitable or high-wage industries,9 and the ‘fissuring’ of the workplace (as companies increasingly outsource non-core business functions) (Weil 2014).10
The declining worker power hypothesis builds on the work of a generation of labour economists. Industrial organisation economists are, however, typically less convinced by arguments that there has been a broad-based increase in monopoly power. For example, Carl Shapiro (2018), despite being an enthusiastic proponent of more aggressive antitrust, is critical of the “rising monopoly power explains macro trends view” taken by the Obama CEA and others. Among the points he makes are (1) rising industry-level national concentration does not necessarily reflect rising concentration in the markets firms compete in, (2) rising national concentration levels may reflect increased competition as successful firms spread their business, (3) industries may become concentrated as efficient firms compete and win market share, and (4) even where concentration ratios have increased they are most often below thresholds that usually raise profit concerns (see also Syverson 2019, Berry et al. 2019, and Basu 2019). In addition, we note that the substantial decline in the large firm wage premium is the opposite of what one would expect to see if large firms were gaining more monopoly power.
Broader implications of the declining worker power hypothesis
We are convinced on the basis of these considerations that the declining worker power hypothesis is the right master narrative for understanding trends in the distribution of income, profitability, and the NAIRU. Of course, complex phenomena have multiple causes. And the declining worker power hypothesis is to some degree intertwined with other explanations for recent developments. If firms had no product market power, there would not be rents for workers to capture. Both technological developments and globalisation, by influencing the ‘outside options’ of firms, influence the extent to which workers can exercise power. Nonetheless, we believe the declining worker power hypothesis should play a major role in thinking about macroeconomic and labour market policy going forward.
Specifically, it suggests that fatalism about changes in the distribution of market income is unwarranted. Alongside progressive taxation and redistribution, policymakers concerned with equity and fairness might consider changes to the structure of capitalist institutions to rebuild countervailing power for workers (of the sort initially proposed by Galbraith 1952). Of course, the challenge would be to do this without introducing labour market rigidities sufficient to create a large increase in the NAIRU. The type of unemployment that risks being created by any policies should be considered, as well as the level. An increase in unemployment arising primarily from an increase in short-term ‘wait unemployment’, as workers spend longer searching for good jobs, is likely to be less of a problem than the development of a two-tier labour market where unprotected ‘outsiders’ spend long periods in unemployment (or are unable to access good jobs at all). In the design of new labour market institutions for the US economy, much can be learned from comparisons with the labour markets of other industrialised economies.
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1 Baqaee and Farhi (2020) outline three measures for firm-level markups in the U.S. data: (1) Accounting profits approach, (2) User cost approach, (3) Production function estimation approach. All three of these methods for measuring markups include some measure of costs, including labour costs, in the denominator. This means that if rent-sharing with labour falls, measured labour costs will fall, leading to an increase in measured markups without any changes in the underlying product market power of a firm. This is illustrated in more detail below.
Accounting profits approach: This is the simplest approach to markup measurement. If one assumes that operating income is equal to profits, this implies that markups are equal to sales divided by costs. Baqaee and Farhi (2020) use the expression
to back out firm-level markups µ, measuring operating surplus as operating income minus depreciation from Compustat data. Firm-level operating income is measured as revenue minus costs, where costs include labour costs. If rent-sharing with labour falls, measured labour costs will fall, leading to an increase in measured markups.
User cost approach: The user cost approach, used by Gutierrez and Philippon (2017) and Baqaee and Farhi (2020), is similar to the accounting profits approach – but, with a more sophisticated consideration of the cost of capital. In this approach markups are estimated as the ratio of sales to total average costs, which are calculated as operating expenses plus an imputed cost of capital. Markups can be estimated from the expression
where operatingsurplusi,t is the operating income of the firm after depreciation and minus income taxes, rkt,t is the user-cost of capital and Ki,t is the quantity of capital used by firm i in period t. Once again, since firm-level operating income is measured as revenue minus costs, where costs include labour costs, then if rent-sharing with labour falls, measured markups will mechanically increase.
Production function estimation approach : The production function estimation approach, used by De Loecker, Eeckhout, and Unger (2020) (and based on De Loecker and Warzynski (2012)), estimates firm-level markup as a function of the estimated elasticity of output with respect to variable inputs,
and the ratio of sales to variable costs,
To measure variable costs in the (imperfect) US firm level data, DLEU use Cost of Goods Sold (COGS). Other authors have used instead COGS+SGA (Cost of Goods Sold, plus Sales, General, and Administrative) expenses. The elasticity of output with respect to variable inputs is estimated using the production function estimation technique as outlined in Appendix A of their paper. DLEU note that most of the rise in aggregate markups they identify is still present holding the elasticity term constant: that is, comes from an increase in the ratio of sales to variable costs. But note that – in a model of the world where firms earn some rents, and workers’ compensation includes these rents – some rents to labour will be included as part of the measure of variable costs. This means that a decline in rent-sharing with labour would show up under this measure as a decline in COGS relative to sales, and therefore would lead to a mechanical increase in the measured markup with no change in the underlying product market power of the firm.
2 Kristal (2010) and Jaumotte and Osorio Buitron (2015) argue that differential declines in worker power across countries can explain differential patterns of change in the labour share (and income inequality).
3 Alongside its contribution to the fall in the labour share, declining worker power likely had substantial implications for labour income inequality. DiNardo, Fortin, and Lemieux (1996), Farber, Herbst, Kuziemko, and Naidu (2018), and Fortin, Lemieux, and Lloyd (2019) present evidence that the decline in unionization can explain a large proportion of the rise in U.S. income inequality. In our paper, we find that the decline in labour rents was much greater as a share of compensation for non-college workers than for workers with a bachelors’ degree.
4 “Wait unemployment” refers to the idea that, in a world where a given worker could get jobs with very different wages – some jobs with high rents, and others with low rents – unemployed workers have the incentive to spend longer searching for a high-rent job, increasing aggregate unemployment. A related concept is “rest unemployment”, where unemployed workers in high-rent sectors facing temporary downturns wait for their jobs to return.
5 We have reason to believe that both the Figura and Ratner (2015) estimate and our estimate of the effect of the decline of worker power on the NAIRU may be underestimates of the true effect, since they are based on state/industry-level variation which may miss some aggregate effect, and since the imperfection of the labour share (in the case of Figura and Ratner) or the imputed labour rent share (in our case) as proxies for the decline in worker power is likely to cause attenuation bias.
6 See, for example, Blanchard and Giavazzi (2003), Geroski, Gregg and Van Reenen (1996), and Ebell and Haefke (2009).
7 Note, however, that it is unlikely that the decline in unionization was only driven by economic factors. First, the proportional decline in the unionization rate from the mid-1980s to the mid-2000s was almost identical across a range of sectors which had very different exposures to globalization, technological change, and deregulation over the period in question, and the rate of unionization has declined much more quickly in the U.S. than in most other industrialized economies, despite relatively similar exposure to trends in globalization and technology (Schmitt and Mitukiewicz 2012, Denice and Rosenfeld 2018). In addition, while Acemoglu, Aghion and Violante (2001) argue that the decline of unionization was driven by skill-biased technological change, Farber et al (2018) find that the pattern of decline of U.S. union membership is unlikely to be consistent with this.
8 See, for example, Shleifer and Summers (1991), who argue that a primary effect of hostile takeovers is the redistribution of value to shareholders from other stakeholders. Some evidence consistent with this mechanism can be found in Davis, Haltiwanger, Handley, Lipsius, Lerner, and Miranda (2019), who find that wage premia in target firms were largely erased after private equity buyouts.
9 We estimate the large firm and industry wage premia in our paper using the CPS. See also Hollister (2004), Even and Macpherson (2014), Cobb and Lin (2017), Song et al (2019) on the decline in the large firm wage premium, and Kim and Sakamoto (2008) on the decline in inter-industry wage differentials. See Bell, Bukowski, and Machin (2019) on the declining passthrough of profits to pay.
10 See also Bernhardt et al (2016) and Bidwell et al (2013) on the “fissuring” of the workplace, and Dube and Kaplan (2010), Dorn, Schmieder, and Spletzer (2018), Mishel (2018), Wilmers (2018), Handwerker (2018), and Song et al (2019) for evidence consistent with “fissuring” leading to lower wages.
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