(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:
This is great for workers, of course. It may also come as a slight relief for economists, whose standard models of the macro economy 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. And that’s in part because the labor market is tightening. The pool of surplus workers is shrinking as more people reenter the labor force and as unemployment falls.
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 also 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 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.