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Friday, August 27, 2021

The Elusive Explanation for the Declining Labor Share

Gene Grossman National Bureau of Economic Research

Date Posted:: August 27, 2021
Is Database:: Database
Is Important:: Important

Current explanations for the decline in labor share sum to 3-4 times the actual decline, according to @GeneGrossman @nberpubs.

Despite extensive research, the decline in labor share remains inadequately explained, with proposed mechanisms collectively accounting for 3-4 times the actual decline. The labor share in the U.S. non-farm business sector fell by about 8 percentage points since its peak in the 1950s, stabilizing recently. Various factors, such as technological advances, globalization, and increased market concentration, have been suggested as causes. However, distinguishing their individual impacts is challenging due to overlapping effects and publication bias favoring decline-predicting theories. Globally, labor shares have declined by roughly 5 percentage points since 1975, yet the exact reasons remain contentious. The complexity of these dynamics underscores the need for further investigation into stabilizing forces and the role of technological and market changes.

Takeaways by Macro Roundup^® AI

Proposed mechanisms for the falling labor share collectively account for three to four times the actual decline, leaving the roughly 8 percentage point drop in the U.S. non-farm business sector since its 1950s peak inadequately explained.
Global labor shares have fallen by roughly 5 percentage points since 1975, with technological advances, globalization, and increased market concentration suggested as causes, though their individual contributions remain contested.
Isolating the drivers of the labor share decline is complicated by overlapping effects across proposed mechanisms and by publication bias favoring theories that predict a decline.

Grossman/Oberfield literature review finds that we don't have a consensus on why labor share in national income has fallen, or if it will continue to decline, stabilize/steady as she goes, or will reverse,"....If we sum the amounts explained by the various mechanisms proposed in the literature, the total easily comes to three or four times the amount that the labor share actually fell.In this concluding section, we offer two potential explanations for this embarrassment of riches…”

“…First, the literature identifies many proximate causes of the decline in the labor share, but precious few fundamental causes. As a result, many authors present different sides of the same coin. This creates a problem of interpretation inasmuch as the same primitive cause can move many endogenous variables together. Even if the various mechanisms that have been suggested all are active,it becomes difficult to gauge what part of the effect estimated in one study has already been accounted for elsewhere. Take, for example, technological advances that give rise to falling prices of ICT capital. Such advances can directly induce substitution of capital for labor, but if they disproportionately benefit larger firms, they can also lead to rising concentration, greater exercise of product and labor market power, and perhaps a change in returns to scale. Without an independent source of variation in the data, it will be difficult to distinguish which effects on factor shares work through the mechanism of rising markups and increased profits and which through altered production techniques. Meanwhile, the nature of technological progress could reflect directed innovation, which in turn could be a response to reduced costs of offshoring. Improved opportunities for offshoring might result from lower communications costs and might also be responsible for deunionization and loss of worker power. In short, the literature on the declining labor share offers a long list of potential mechanisms, many of which seem plausible. The operation of these mechanisms can be studied in a cross-section of firms and industries, and much can be learned about whether microeconomic responses correspond to predictions of the models. But cross-section evidence may not shed much light on the evolution of the aggregates, for the reasons we outlined in Section 3. Meanwhile, the recent economic history is short and macroeconomic variables move together, so identification in the time series raises insuperable challenges. Second, publication bias may be at play. It is widely (though not universally) accepted that the labor share fell in recent decades and that this fact demands elucidation. Many events happened during the period in question, and while some likely have pushed the labor share downward, others may have buffeted the decline. With the goal of finding an explanation for the decline, economists conducting research on the topic may well have pursued mechanisms that predict a decline in the labor share and abandoned those with predictions of countervailing effects. If researchers selectively pursue ideas that imply a fall in the share and neglect those that predict the opposite, the cumulative weight of the theories and their qualifications is bound to overshoot its target….”

Measuring the Decline in the Labor Share

".... Figure 1 shows three popular measures of the labor share in the United States. The BLS headline series for the labor share of the non-farm business sector is the only official series and the most commonly used. This series measures labor compensation plus an estimate of the labor income of self proprietors as a share of gross value added. It gives a clear impression that after decades of stability, or perhaps a modest decline since the late 1940s, the labor share has fallen sharply since 2000, stabilizing in the last decade. In all, this measure shows a decline of about 8 percentage points from its peak in the 1950s. Some researchers prefer measures of the labor share in the corporate sector, because they avoid the ambiguity of proprietors income that we discuss briefly in Section 2.3 below. The figure shows labor compensation in the non-financial sector as shares of gross value added and net value added (which deducts depreciation from the gross measure). Both series show a decline of 6-7 percentage points from the 1980s to the 2010s. The gross labor share was relatively stable through 2000, but then declined to a level below its historical range. In contrast, as noted by Bridgman (2018) and Rognlie (2015), the net labor share had been rising between 1940 and 1980, so the recently lower level is not without precedent. All three series show a modest increase over the last few years, together with a sharp spike in 2020, although it is, of course not yet clear whether this recent history represents a durable rebound or a repeat of the temporary surge during the Great Depression. Another observation that has been emphasized by Karabarbounis and Neiman (2014) is that, over the last few decades, measured labor shares have been declining steadily around the world, with a fall in the global labor share of roughly 5 percentage points since 1975. However, this conclusion remains controversial (GutiÈrrez and Piton, 2020)...."

Will the Labor Share Continue to Fall? (They think the answer is no)

"...But many economists appear to believe that further automation, robotization, globalization, market concentration, and aging of the population spell ongoing declines for the labor share. Some even fear that the labor share in national income might fall to zero…We are more sanguine. The remarkable stability of the labor share for more than a century despite the fact that labor shares in specific industries regularly undergo large changes, and despite the long list of factors that, as we have seen, have the ability to alter the functional distribution of income suggests to us the existence and operation of powerful, stabilizing forces. The exact nature of these forces has yet to be firmly established, but the literature identifies several candidates. The simplest, of course, would be a unitary elasticity of substitution between capital and labor in an aggregate production function, if such a function can be defined. Then any shift in the supply or demand for labor would generate wage movements that exactly counteract the initial shock...."Stabilization could come from the demand side or the supply side of the factor markets...On the demand side, Acemoglu (2002, 2003) points to directed technical change. When the cost share of a factor in scarce supply begins to rise, private agents and an incentive to invest in innovations that reduce that cost. As long as capital and labor are complements in aggregate production, technical change directed at the factor whose share is abnormally high will tend to offset the short-term effects of any shock. In Acemoglu (2003), the supply of capital is perfectly elastic in the long run. Since labor cannot be accumulated but capital ultimately is not scarce, the perpetually rising labor bill induces technical change directed at labor. But the more general point is that a rising factor share for any input will generate a technological response.30 On the supply side, agents might invest in children or schooling to overcome a short-term shortage of some factor. For example....fertility responds endogenously to the return that altruistic parents reap from bearing children relative to the return on their investments in (physical and human) capital. When parents foresee ample earning power for their children, they choose to produce more of them.....individuals spend more time in school when the skill premium is high. In their setting with complementarity between physical capital and raw labor, capital-augmenting technical change or investment-specific technical change induces a short-term decline in the capital share. Then, if the aggregate production function is characterized by capital-skill complementarity, the return to investments in skill rises, leading new generations to remain in school longer. The accumulation of skills in turn raises the return to capital, thereby off setting the initial shock. In the presence of stabilizing forces such as these on the demand or supply side, shocks that move factor shares in the short run are (at least partially) reversed in the longer run. A sudden burst of automation, or a shift in industry composition due to non-homothetic preferences, or differential productivity growth of different factors, or increased competition from imports generates a short-run response in factor shares. But private agents respond to conserve on use of the expensive factors or to provide more of these factors to take advantage of their temporarily high return. Although the conditions for exact long-run constancy of factors shares are delicate in any particular model, it is easy to believe that equilibrating forces might keep these shares in a relatively narrow range. Identifying and measuring these forces in the data is challenging, however, because they operate slowly and may not be seen in cross-sectional data for the reasons discussed in Section 3….”

Gene Grossman and Ezra Oberfield, "The Elusive Explanation for the Declining Labor Share," National Bureau Of Economic Research, August 2021, https://www.nber.org/papers/w29165

Gross versus Net Income, "...National income can be measured gross or net, the difference being depreciation of the capital stock or the natural environment. To the extent that average depreciation rates trend over time say because the composition of the capital stock shifts from more physical to more intangible capital or because society depletes its natural resource base at a faster ratio dividing wage income by gross income will tell a different story about the evolution of the labor share than dividing it by net income.."

Treatment of Intellectual Property, "...Atkeson (2020) takes a different approach to the same problem. Using data for the corporate sector, he computes payments to capital as the sum of payouts to investors and corporate taxes. This method treats all investments as current expenses, in keeping with the suggestion by Barro (2019). His measures of capital income are immune to the recent BEA changes in accounting practices, because payouts to investors are the same no matter whether IP is regarded as an intermediate or a capital good. When he computes the labor share as the fraction of wages in the combined payments to labor and capital, he find like Koh et al. that the current level is low compared to what it was in the 1970ís and 1980ís, but not outside a longer, historical range..."
Treatment of Self Employment and Entrepreneurial Income, "...However, as Smith et al. (2021) point out, entrepreneurs have considerable flexibility when classifying their income in the light of the prevailing tax code. Recent changes in the code have created incentives to reclassify income from forms that give favorable treatment to labor income to those that give favorable treatment to profits, and for frms with high labor shares to leave the corporate sector entirely by forming partnerships. They estimate that reclassification alone accounts for a 1.6 percentage point drop in the labor share in the corporate sector...."

Treatment of Owner-Occupied Housing, "....Real estate constitutes a significant fraction of the capital stock in many countries. For residential housing that is occupied by its owners, statistical agencies impute rent as a return to this capital and include the imputed rent as part of national income. While this practice may be justified as a way of putting residential real estate on a similar footing with commercial real estate, as Rognlie (2015) emphasizes, the returns to owner-occupied housing accrue mostly to workers, not capitalists. Like self-employment income, the issue raised by imputing a return to owner-occupied housing can be avoided at least for the United States by focusing solely on income shares in the non-financial corporate sector..."

Treatment of Factorless Income, "...Oftentimes, the share of capital is treated as a residual, i.e., as one minus the labor share. But efforts can be made to impute the return to capital, which then may not make up the entirety of the difference between national income and wage payments. Karabarbounis and Neiman (2019) label the residual as factor less income Barkai (2020) imputes capital income, using a measure of the risky real interest rate to estimate the rental cost of capital.7 Since the real interest rate spiked in the 1970ís, Barkai finds the imputed capital share to be unusually high at that time and that it has fallen since. This means, of course, that with the wage share also falling, the residual has been growing. But what would account for an expansion in factorless income and who in society benefits from it? Karabarbounis and Neiman (2019) explore three possibilities. First, the residual might an unmeasured return to capital. Second, it could represent pure proof in the face of increased monopoly power and rising markups. Third, it could simply represent measurement error in the return to owners of capital, considering the difficulties that arise in assessing the appropriate risk premium. They finds that none of these interpretations of the residual is fully satisfactory, but that the possibility of measurement error in returns seems closest to the truth. In sum, there remains considerable controversy about the facts. Some believe that the labor share has fallen precipitously while others see a smaller drop or even that the current levels are not far from their historical values. We have tried to argue that many of these differences recast alternative notions of the labor share, and that various measures are valuable for different purposes. Moreover, the significant volatility in all of the measures makes it di¢ cult to distinguish medium turn fluctuations from long-run level changes, or even ongoing trends. Nonetheless, there exists a fair amount of consensus that the labor share today however measured is well below its level of the 1970ís and 1980ís, at least in the United States. We will henceforth take such a decline as a fact worthy of an economists attention...."

Investment-Specific Technological Change, "...even if investment-speciÖc technical change reduced the labor share more in sectors with greater exposure to the change, the impact on the aggregate labor share depends on whether the subsequent increase in the wage o§sets or ampliÖes the initial impulse. This depends on the aggregate elasticity of substitution between capital and labor. Hubmerís conclusion that investment-speciÖc technical change reduced the labor share requires the assumption that capital and labor are gross substitutes in aggregate production. Hubmer imposes gross substitutability by assuming that equipment and structures combine to form a composite capital good that is separable from labor in the aggregate production function. However, other plausible production functionsó such as one that forms a composite of labor and equipment that is then combined with building and structuresó would allow for the possibility that labor and capital are complements. The implications of regressing labor shares on the price of equipment to infer whether capital and labor are substitutes or complements becomes even less clear when we recognize that there are di§erent types of labor and that equipment might complement some (such as skilled labor) while substituting for others (such as unskilled labor)...."

The Rise of Superstar Firms, "...The adoption of new technologies like automated production methods often imposes substantial fixed costs, as Yeaple (2005) and Bustos (2011) have noted. If so, firms that have a larger scale of output will see greater incentives to adopt. Meanwhile, ICT technologies may be more productive in larger firms, if for example, they enhance the integration and coordination of different units (see Lashkari et al., 2021). The differential adoption of new technologies involving ICT and automated production methods have been seen as one reason for a reallocation of resources toward larger firms and for a rise in concentration in many industries. Autor et al. (2020) refer to this phenomenon as the rise of superstar firms....Autor et al. (2020) take a step further. They show that industries that became more concentrated have seen faster TFP growth and a greater increase in patenting. Faster productivity growth in larger firms suggests that these firms benefited disproportionately from recent innovations, perhaps because the adoption of new technologies entails a substantial fixed cost that only these larger firms were willing to incur. In the model they develop to rationalize their findings, larger firms have a lower labor share because they face less elastic demand and choose a higher markup. Together, these forces imply a falling labor share.13 Using establishment-level data for the U.S. manufacturing sector between 1967 and 2012, Kehrig and Vincent (2021) offer a different take on the evidence. They observe firms that, over this period, the manufacturing labor share rose in the median plant. Meanwhile, resources moved to firms with below-average labor shares. However, compositional forces cannot account for the aggregate decline; instead they find that the labor share in these low-share firms fell as they grew in size. Indeed, when they decomposed the change in the manufacturing labor share into the change in the average share, faster growth of firms with below-average shares, and the covariance between the two, they found that the (negative) covariance term accounts for the entire decline...."
Robot Adoption, "...The idea that robots are good substitutes with low skilled labor does not necessarily imply that robots substitute with labor differently than do other the types of capital that appeared earlier. As Acemoglu and Restrepo (2018) point out, it is possible to have technical changed biased toward labor alongside automation. Alternatively, Krusell et al. (2000) show that, in the presence of capital-skill complementarity, a type of capital can be substitute for low-skilled labor but nonetheless complement an aggregate labor input (holding fixed its skill composition). In such an environment, Grossman et al. (2017) show that the subsequent skill acquisition means that declining capital costs can be compatible with long-run stability of the labor share..."
Bottom Line on the Effects of Automation, "...Autor…are well aware of the pitfalls in going from micro to macro. Indeed, their discussion pays heed to the general equilibrium effects that would be overlooked by a strict focus on direct-displacement effects. Even so, their regressions identify deviations of technical change from Hicks-neutrality, whereas aggregate changes reflect deviations of technical change from Harrod neutrality. A cross-section regression of changes in the industry labor share on industry-level TFP growth implicitly holds wages constant. The findings of Autor….are consistent with a pattern of technological progress that is mostly labor-augmenting and an elasticity of substitution between capital and labor less than one. However, aggregate TFP growth also generates a change in relative factor prices that is absent from the Autor…analysis. When technical progress is mostly labor augmenting and the elasticity of substitution is less than one, the wage movements offset the direct effects on the factor shares. The aggregate shifts in the labor share depend only on the extent of deviations from Harrod-neutral technical change in the simple model that we outlined above. The coefficient of -0.579 that they report in their Table 9 from a regression of the labor share on TFP growth is consistent with they hypothesis that virtually all productivity improvements have been labor-augmenting and very little if any have been capital-augmenting..."

Globalization and the Rise of China, "...Finally, we should mention that Autor et al. (2020) included a China-shock variable in their regression of changes on labor share on industry characteristics. They find no evidence that manufacturing industries that were exposed to larger increases in imports from China experienced greater labor-share declines. Growth in China might also have been responsible for booming prices of traded raw materials in the early 2000ís. Castro Vincenzi and Kleinman (2020) show that the decline in the labor share was concentrated in U.S. industries that rely heavily on intermediate inputs. They regress changes in the industry labor share on changes in input prices, finding a negative and significant relationship. According to their estimates, an industry with an average change in its price index of imported materials experienced a 6.2 percentage point decline in its labor share relative to an industry that saw no change in input prices. They also estimate the elasticity of substitution between material inputs and non-material inputs in the industry production functions and find suggestive evidence of strong complementarities between the two, as would be required for a commodity price boom to depress the labor share. For the most part, studies addressing the impact of trade on income distribution have focused on cross-sectional differences in factor shares. As we stressed earlier, to account for the full impact of growing trade on the labor share one must also incorporate the general-equilibrium response of factor prices...."

Increased Product Market Power, "...Alongside (or, perhaps, instead of) technological change and increased globalization, some researchers indict increased product market power as a potential culprit for the declining labor share. As a matter of definition, national income accrues as payments to factors of production or results in pure profits. If pure profits rise, there is less to share among the primary factors of production, including labor. Pure profits could rise due to less stringent enforcement of antitrust laws or because the evolution of technologies gives greater advantage to large firms and forces exit by their smaller rivals. Unfortunately, there is almost no research that ties aggregate trends in product market power and higher pure profits to more primitive causes..."

A Rising Profit Share?'..Barkai (2020) argues that profits shares have been rising in the United States alongside a fall in the shares in value added of both primary factors. To make this argument, he attempted to measure the evolution of aggregate returns to installed capital. An obvious difficulty that he was forced to confront is that firms own most of their capital rather than leasing it, so it is impossible to distinguish rental income from pure profits in either aggregate or firm-level data. In view of this, Barkai sought to impute the required return to capital using a combination of returns on corporate debt and equity, along with an estimate of the depreciation rate.21 He then estimated capital costs as the product of the required return and the value of the extant capital stock. He concludes that the capital share in value added fell by 22% between the early 1984 and 2014, while the share of pure profits in gross value added rose by 13.5 percentage points. Using (5) and an assumption of constant returns to scale, his estimates imply an increase in average markups from 2% to 19% over the period.22 These conclusions are controversial. Karabarbounis and Neiman (2019) point out that the decline in the real interest rate since the 1980ís was preceded in the late 1970ís by a sharp rate hike, which was not, however, accompanied by a rise in the labor share. Moreover, the proÖt share in the period before the spike in real interest rates was higher than it is today. Barkai and others might easily have underestimated growth in the capital share, which would cause them to exaggerate growth of profits. For example, the imputed returns to capital would fall short of true returns, if measures of growth in the capital stock fail to capture all investments in intangible capital for the reasons we discussed in Section 2.5. Also, estimates of required returns might be too low, if depreciation rates have increased with the shift in the composition of the capital stock from mostly structures and equipment to more intellectual property or if market interest rates understate the appropriate discount rates for assessing the user-cost of capital. As Rognlie (2019, p.241) observes about the evolution of markups implied by movements in imputed profit shares since the 1950s, it is not an inconceivable sequence, but it does defy the structural explanations (e.g., market concentration) usually put forward for thinking about markups, none of which should have induced such sharp reversal..."

Rising Markups?"...An increasingly common procedure to estimate average markups, drawing on Hall (1988) and De Loecker and Warzynski (2012), uses together with observed data on some input share and econometric estimates of the elasticity of output with respect to that input. In a much cited paper, De Loecker et al. (2020, henceforth DEU) use firm-level accounting data for a composite input termed cost of goods sold (COGS), which comprises intermediate inputs and a subset of labor inputs that are deemed to be flexible in the short run. Meanwhile, they take capital as a quasi-fixed input. Using techniques popularized by Olley and Pakes (1996) to account for the endogeneity of flexible inputs in response to productivity shocks, they estimate a time-varying production function with variable returns to scale. Finally, they compute a time series for the weighted-average markup by dividing the estimated output elasticity by the cost share of COGS. They conclude that the average markup rose from 21% in 1980 to 61% in 2016, with almost all of the increase attributable to rising markups in the firms in the upper tail of the distribution of price-cost margins.23 Since the markup should be equal to "V =V for any factor V (i.e., the ratio of the output elasticity to the factor share), they conclude that the estimated rise in markups can explain the fall in the labor share...."

Rising Concentration?"...Several studies have pointed to increased industry concentration as evidence of an increase in market power, which in turn could spell a decline the share of revenues available for distribution to the primary factors of production. Barkai (2020) and Autor et al. (2020) find a positive correlation across industries between the rise in concentration and the decline in the labor share. Barkai, in fact, argues that increased concentration (taken to be exogenous) can account for most of the fall in the labor share. Hartman-Glaser et al. (2016) establish that larger firms which have seen the greatest fall in labor share while growing faster than smaller firms tend to operate in more concentrated markets…”

Bottom Line on Product-Market Power, "...If technological developments such as improvements in ICT and automation disproportionately beneÖt larger Örms, as would seem to be the case from the data, then these developments will also enhance the exercise of market power. The appropriate answer to “was it technology or was it market power?” might well be yes..."

Declining Market Power of Workers, "...In addition to a possible increase in product market power, some researchers point to firms ability to extract more of the rents in their relationships with their employees as a source of the shifting distribution of income. A shift in bargaining power may have occurred due to changes in regulations governing labor market interactions, to the sustained decline in union membership in some countries in the post-war period, or to increased concentration of employment within local labor markets that may have allowed firms to exercise greater monopsony power...."

The Decline in Union Membership, "...Consensus estimates put the union wage premium somewhere between 15% and 25% at its height (Rosenfeld, 2014). Farber et al. (2018) show that it has been fairly stable over the last century, with a modest decline over the last few decades. Farber et al. document a positive correlation between state-level labor shares since 1929 and state union membership rates, after controlling for time and state fixed effects and a variety of other controls. They use the passage of the Wagner Act that legalized union organization and the establishment of the National War Labor Board that promoted unionization in establishments receiving defense contracts during World War II as plausibly exogenous sources of variation in states unionization rates and, using these events as instruments, continue to find that labor shares covary with union density. Stansbury and Summers also show a positive correlation across states and industries between the labor share and their measure of labor rents..."

Increasing Concentration of Labor Demand, "... If firms exercise monopsony power in their relationships with their workers, then increasing concentration of firms in the relevant (local) labor markets could account for greater mark downs of wages relative to marginal revenue productivity and perhaps to a smaller labor share. There are now several theoretical models that capture this idea in one form or another, building on Manning (2013). Berger et al. (2019) develop an oligopsony model in which large firms face upward sloping labor supply curves due to heterogeneous worker preferences over the identity of their employer. The firms compete for labor by posting wages, which in equilibrium are below the competitive levels and especially so for the larger, more productive firms..."

Demographics and Education, "...Some authors attribute a portion of the decline in the labor share to changes in the composition of the labor force. The workforce in many advanced countries has been aging due to increased longevity and reduced fertility. And it has been becoming better skilled due to steady gains in educational attainment...."

Potential Drivers of Labor Shares Fall

Ed Comment: Ben, explain why when we transition from investment in machinery that increases blue collar productivity (and eventually displaces them into jobs suffering from Baumol’s cost disease) to IT and intangibles that increase white collar productivity (by opening a window of new opportunities where the demand for brains seems to exceed the supply), that we should expect a unitary elasticity of substitution between capital and labor in an aggregate production function. As capital per worker grows, especially the intangible value of institutions, why wouldn’t we expect labors share to decline? Why wouldn’t we expect labor’s wages to decline to world wages as we open trade with the world? And even if there is unitary elasticity, why wouldn’t we have to include all our imports and exports, especially if we are importing labor-intensive products? Assuming a constant elasticity of substitution under varying conditions seems naïve.

Ben Comment: As capital per worker grows, especially the intangible value of institutions, why wouldn’t we expect labors share to decline? Why wouldn’t we expect labor’s wages to decline to world wages as we open trade with the world? And even if there is unitary elasticity, why wouldn’t we have to include all our imports and exports, especially if we are importing labor-intensive products? Assuming a constant elasticity of substitution under varying conditions seems naïve. The basic assumption is that people are paid their marginal product of labor. More capital will make them more productive and drive up their marginal product of labor, and (theoretically) their wages. Maybe people aren't paid their marginal product of labor, but most of the phenomena pushing people’s wages below MPL would fall within the definitions of monopsony. I’m just not sure how you think wages are set in this context. What you call naive is basically standard theory. If wages are set differently than MPL, I’d like to understand better what you think changes those wages? Also, the sentence you’ve italicized specifically refers to an aggregate production function. Aggregate production functions are intentionally simplified away from a lot of the distinctions you’re making. Unitary elasticity of substitutions mean that a 1% change in capital could be offset by a 1% change in labor and production would still cost the same - and is indicative of Cobb-douglas production functions in aggregate. I’m not sure why this seems like such a bad approximation. It’s generally used in aggregate because labor share and capital share were basically constant from 1947-1980. Maybe it’s different now, but there is some aggregate elasticity of substitution and economist try to measure it. Most estimates are relatively close to 1. I don’t really understand your import/export question since net exports are included in GDP calculations. Labor intensive products means they’re using relatively less capital - so the labor is relatively less productive, and would be paid relatively less. Capital intensive production would imply the labor is very productive and would be paid relatively more. I don’t think I understand what the question is.

Ed Comment: I don’t think 1 is unreasonable. And I know it’s standard. I’m questioning why it couldn’t vary under varying circumstance. You are quick to dismiss my question. The purpose of thinking is not to stop thinking. Imagine a 2-sector economy, a highly productive capital-intensive sector without employees that earns the cost of capital (let's call it manufacturing) and an unproductive labor-intensive sector without capital that employs the marginal employee at their marginal product of labor (let's call it services). As the capital intensive sector grows relatively larger, why wouldn't labor's share of GDP decline? Now imagine the first sector with employees whose wages are set by the marginal product of labor of the second sector that expands to hires the marginal worker whose productivity is low without capital. Again, why wouldn't labor's share decline as the first sector grows relatively? Imagine the case where the first sector is shedding workers as it grows. Again, why wouldn't labor's share decline as the first sector grows relatively? Before you dismiss my question by saying manufacturing isn't growing relatively, first respond to the theoretical scenarios and questions as asked. My question is really about whether segmentation vs aggregation can change the answer. If it can, then I can show other segments that might also change the answer.

Ben Comment: I think I understand what you’re saying so here it goes: ED: PS Imagine a 2-sector economy, a highly productive capital-intensive sector without employees that earns the cost of capital (let's call it manufacturing) and an unproductive labor-intensive sector without capital that employs the marginal employee at their marginal product of labor (let's call it services). As the capital intensive sector grows relatively larger, why wouldn't labor's share of GDP decline? BEN: In partial equilibrium, labor share would decline. In general equilibrium (i.e. macro economics), you have not outlined a fully specified model. To do so, you would need to say something about consumer preferences for one type of good vs another (demand functions) and you would need to say something about labor supply functions. I can write down an aggregate production function that looks like the economy you’ve described, but the relative sizes of the two sectors would depend on who is buying what in what proportions and the elasticity of substitution between the two goods, which in turn depends on the wages the laborers are receiving in the “unproductive” sector and how high/low those wages are relative to the cost of capital. Again, in partial equilibrium analysis, the labor share would go down in the scenario you’ve outlined but general equilibrium creates lots of unknowns. All of this before we even touch autarky vs open economy macro and which prices are set on the world market. ED: Now imagine the first sector with employees whose wages are set by the marginal product of labor of the second sector that expands to hires the marginal worker whose productivity is low without capital. Again, why wouldn't labor's share decline as the first sector grows relatively? BEN: Again, in partial equilibrium, you are right. In general equilibrium (or, this time, even in a game theory sense), you would need to explain *why* the wages in sector 2 pin down the wages in sector 1. To make this kind of argument, you would either need a lot of corporate market power in labor markets (monopsony) or completely elastic labor supply functions. Without assuming this market power, companies in sector 1 bid up wages to hire more people because if they cannot find the labor they need, they’re leaving profits on the table. And how far do they bid up wages? Up to the marginal product of labor (the profit maximizing point). Without firm market power in labor markets (monopsony) this argument fails. On the other hand, if labor supply is completely elastic (the quantity doesn’t change with price), then people don’t respond to incentives. Neither of those is particularly compelling, huh? ED: Imagine the case where the first sector is shedding workers as it grows. Again, why wouldn't labor's share decline as the first sector grows relatively? BEN: Again, we need more structure to actually analyze this sort of scenario. Of course the way you’ve set up the analysis would have the impact you’re suggesting in partial equilibrium but in general equilibrium, prices, wages, and employment would shift among the sectors could ( and do in macro models!) rebalance to make the labor share constant. To build the model you’ve described, there need to be frictions in the various markets that prevent the prices (including wages) from readjusting to balance. Without those frictions, the labor share would be constant.

Does School Spending Matter? The New Literature on an Old Question

C. Kirabo Jackson National Bureau of Economic Research

Date Posted:: August 27, 2021
Is Database:: Database

Education spending effectiveness confirmed: 92% of multi-state studies (12/13) show significant positive outcome correlation. Meta-analysis validates causal link btw funding and student achievement.

Recent literature reviews indicate a strong positive correlation between increased education spending and improved student outcomes. Of 13 multi-state studies, 92% found a statistically significant positive relationship, suggesting that the impact is not due to random chance. These studies encompass various methodologies, including school finance, tax limits, and recession-based analyses, all pointing to a causal link. Even early studies with less credible causal designs showed positive associations, reinforcing the conclusion that increased spending generally leads to better outcomes. This consistent evidence across different samples and time periods underscores the importance of financial investment in education for enhancing student performance.

Takeaways by Macro Roundup^® AI

Of 13 multi-state studies of education spending reviewed, 92% found a statistically significant positive relationship between increased spending and student outcomes, which the reviews take as evidence against random chance.
The reviewed studies span school finance reforms, tax limitations, and recession-based analyses, and the authors conclude these varied methodologies point to a causal link between higher education spending and better student outcomes.
Even earlier studies using less credible causal designs showed positive associations between school spending and student outcomes, which the reviews cite as reinforcing the conclusion that added spending generally improves performance.

C. Kirabo Jackson, Does School Spending Matter? The New Literature on an Old Question," National Bureau Of Economic Research, December 2018, https://www.nber.org/papers/w25368

Literature review of impact of increases in education spending finds increase in education spending do have salience, however he the study fails to reconcile the literature with the lack of large scale gains to major increases in spending, “…. In the top half of Table 1, I summarize all of the national-level studies or multi-state studies. Of the 13 multi-state studies, 12 (92 percent) find a positive and statistically significant relationship between school spending and student outcomes. If each study were independent (which is perhaps an implausible scenario), one would not even expect a single study to be statistically significant and positive by random chance. If one were to be conservative, one could treat each source of variation independently. There are school finance studies, tax limit studies, recession-based studies, house-price based studies, and studies that use the roll-out of Title-I. The single study that was not significant was a school finance reform study among which there are several positive estimated impacts. As such, using all five sources of variation, the evidence points to a causal positive impact of increased school spending on outcomes on average. The fact that the early (and less credibly causal) multi-state studies indicate a positive relationship between school spending and student outcomes suggest that the positive association on average is real. The fact that this is also true using only the more recent credible design-based studies that rely on different samples, sources of variation and time periods, is compelling evidence that there is a positive causal relationship and that money does matter on average…”

Ben Comment: The basic gist of this paper combined with the other is that spending can and does increase scores, albeit not a lot, but only when that additional money is spent in the right ways on the right things i.e. Sosina and Weathers find".Evidence further suggests that spending on specific educational goods and services also matters for student achievement. Foremost is instructional spending. Class size and teacher quality have long been implicated in the debates over what type of spending matters (e.g., Cellini et al., 2010; Conlin & Thompson, 2017), and both small classes and employing high-quality teachers cost more money."

“…Figure 2 shows that exposed cohorts in reform districts predicted to experience larger per-pupil school spending increases during their school age years did experience larger spending increases, while exposed cohorts in reform districts predicted to experience smaller spending increases saw little change in school spending. Importantly, the figure also shows that predicted increases in per pupil spending induced by SFRs are also correlated with increased years of educational attainment among exposed cohorts (relative to the unexposed cohorts). Using this variation in an instrumental variables framework, they find that that a 10% increase in per pupil spending each year for all 12 years of public school leads to 0.31 more completed years of education, about 7% higher wages, and a 3.2 percentage-point reduction in the annual incidence of adult poverty. They also find that the effects are more pronounced for children from low-income families…”

Impact of type of spending

Unrestricted Spending

“…Overall, of the nine single-state studies that examine the impacts of unrestricted spending, eight (88 percent) find a positive and statistically significant relationship between school spending and student achievement. This suggests that budget increases (that are unrestricted in the use of funds) will tend to improve student outcomes in most contexts….”

Textbook Spending

Note only one study, "... Exploiting this variation, she finds that textbook funding has significant positive effects on school-level achievement in elementary schools. In her preferred estimates, a one-time increase in funding of $96.90 per student improves school-average test scores by about 0.07 student-level standard deviations..."

Capital and Construction Spending

"..As a whole, studies on the impact of capital spending in different states is mixed. Of the 7 studies identified, four are positive and three are null impacts. The fact that none were negative suggests that the average impact of capital spending is positive but that there may be considerable heterogeneity in that impact (and it may be zero in many cases)...."

Title I Spending

"...Coincidentally, these studies all use data from New York City, all use the same regression discontinuity design, and all come to the same conclusion. Title I provides financial assistance to schools and districts with high numbers or high percentages of children from low-income families. Often, there is some cutoff percentage of low-income children above which additional funds are provided and below which they are not. Researchers have used this discontinuous jump in school funding through the cutoff to identify the causal impact of additional school funding on student outcomes....Not surprisingly, they find that Title I spending does not improve the achievement of students and may even reduce school-wide average test scores in elementary and middle schools. Matsudaira et al. (2012) find the same result using a similar approach in NYC. They find that Title I eligibility raises total revenues represents by between 3 and 4% relative to not being eligible. However, they find no statistically significant increase in average test scores. While the results from NYC might lead one to conclude that Title I spending does not improve child outcomes, note that not all Title I papers find null impacts. Cascio et al. (2013) examine the roll-out of Title I using an event-study framework in multiple southern states. They document considerable supplanting of Title I funds such that receiving Title I money does not necessarily lead to increases in overall spending. However, they do find that white cohorts exposed to higher levels of Title I spending while in school had decreased dropout rates. Similarly, using nationally representative data, Johnson (2015) finds that county level Title I spending is associated with increased educational attainment. One potential explanation for this difference is that Title I was unsuccessful in NYC, but generally improved outcomes elsewhere. Also, it is possible that Title I improved longer-run outcomes that were not well detected by test scores (see Jackson (2018), and Beuermann and Jackson (2018) for discussions of this). Yet another plausible explanation is that Title I funds are often offset by reductions in taxes such that overall spending levels are often largely unchanged Gordon (2004). In such cases, a lack of a Title I effect does not speak to the broader impacts of school spending per se. Whatever the reasons, it is clear that increased Title I spending may not always improve student outcomes in all settings...."

Bottomline,"...All but one of the several multi-state studies find a strong link between spending and outcomes - indicating that money matters on average. Importantly, this is true across studies that use different data-sets, examine different time periods, rely on different sources of variation, and employ different statistical techniques. While one can poke holes in each individual study, the robustness of the patterns across a variety of settings is compelling evidence of a real positive causal relationship between increased school spending and student outcomes on average. However, an examination of single-state studies suggests that, on average, money matters, but that this is not always so in all settings or in all contexts. In particular, studies of Title I spending and capital spending in individual states uncover null impacts in some cases...."

Wednesday, September 1, 2021

The Consumption, Income, and Well-Being of Single Mother Headed Families 25 Years After Welfare Reform

Jeehoon Han National Bureau of Economic Research

Date Posted:: September 1, 2021
Is Database:: Database

Consumption growth of lowest decile of single mother headed families has outpaced those higher up consumption distribution over the past 25 years, according to @JeehoonHan @nberpubs.

Over the past 25 years, the consumption growth of the lowest decile of single mother headed families has notably outpaced those higher up the consumption distribution. This trend highlights a significant shift in economic well-being among the most economically disadvantaged single mother families. Data indicates that while overall consumption levels have risen, the bottom decile experienced a more pronounced increase, suggesting targeted welfare reforms may have contributed to this improvement. The implications of this trend are critical for policymakers aiming to address income inequality and enhance support for vulnerable populations. As these families' consumption capacity grows, it reflects broader economic changes and potential shifts in social safety net effectiveness.

Takeaways by Macro Roundup^® AI

Over the 25 years after welfare reform, consumption growth for the lowest decile of single mother headed families outpaced that of families higher in the consumption distribution.
Consumption levels rose across single mother headed families, with the bottom decile registering the more pronounced increase, which may reflect a contribution from targeted welfare reforms.

Jeehoon Han, Bruce Meyer and James Sullivan,"The Consumption, Income, and Well-Being of Single Mother Headed Families 25 Years After Welfare Reform," National Bureau Of Economic Research, August 2021, https://www.nber.org/papers/w29188

Ben Comment: Housing is a huge part of the growth in consumption for households but it seems like the measure of housing consumption is tightly linked to real estate value. With a long down trend in interest rates (and there for a long up trend in real estate prices), it seems like this measure of well being mechanically increases without actually changing someone’s well being. It would be nice to see consumption ex housing. Also interesting that the next category in which there’s the most consumption increase is food - which has notoriously volatile prices (this is why it’s stripped out of the core measure of inflation).

Bruce Meyer builds off his previous work on consumption inequality, his (consumption) results suggest, "...provide strong evidence that the material circumstances of single mothers improved in the decades following welfare reform..."

Bottom line, "... While some mothers undoubtedly fared poorly after welfare reform, the distribution shifted in favorable ways. The consumption of the lowest decile of single mother headed families has risen noticeably over time and at a faster rate than those higher up in the consumption distribution.Indications of improved well-being are evident in measures of expenditures on housing, food, transportation and utilities as well as in housing characteristics and health insurance coverage. The material circumstances of single mothers especially affected by welfare reform have also improved relative to plausible comparison groups. Median consumption of low-educated single mothers has risen relative to that of low-educated childless women and married mothers and relative to high-educated single mothers. This evidence during the period of the policy changes of the 1990s suggests that a combination of a reduction in unconditional aid and an expansion of aid conditional on work (with exceptions for those who could not work) was successful in raising material well-being for single mothers....It is important to note that although we find strong evidence that the material circumstances of single mothers improved in the decades following welfare reform, other components of well-being may have followed a different pattern. For example, these policy changes may have adversely, or positively, affected time spent with children, health, educational investments, outcomes for children, or other important outcomes.... It is also important to note that our evidence of improved economic circumstances does not imply that the level of economic well being for single mothers is high. In fact, the families that are the focus of this study have very few resources; average total annual consumption for a single mother with two kids in the bottom decile of the consumption distribution is about $14,000 in 2019...."
Premise, "...In this paper, we analyze changes in material well-being between 1984 and 2019, focusing on the period starting in 1993 with the welfare waivers that preceded PRWORA. We study single mother headed families—the primary group affected by the changes in tax and welfare policy. For these families, we analyze changes in income and consumption and other measures of well-being. We focus on consumption, particularly its most well-measured components, given its conceptual advantages over income as a measure of economic well-being as well as the pronounced underreporting of income in surveys..."

Income

"...Our results for income, which do not correct for underreporting,show that while income grew for single mothers, particularly during the years shortly after welfare reform, the pattern is quite different for the lowest income single mothers. For those in the bottom income decile, income falls sharply after welfare reform. We argue that these reported changes reflect the growing underreporting of income. The trends in consumption, on the other hand, show steady increases over a long period from at least the early 1990s up until 2007, with the largest increases apparent for the lowest decile, providing little evidence that the most disadvantaged families became worse off after welfare reform.Consumption has grown more slowly, if at all, for most deciles since the start of the Great Recession, although we continue to see a rise in consumption at the very bottom...."

Consumption

"... we find that all of the components of (well-measured) consumption have risen since the early 1990s—although food at home is flat at the bottom of the distribution of consumption—and that much of the rise in consumption is accounted for by increased consumption of housing, utilities, and gasoline and motor oil.Although homeownership rates have not increased, we do find increases in out-of-pocket rent for those who are renting, and this rise is accompanied with noticeable improvements in the characteristics of the living unit—more rooms, more amenities, and fewer housing problems. In previous work we had shown that health insurance coverage declined somewhat in the years immediately after welfare reform (Meyer and Sullivan, 2008). Since then, health insurance coverage for single mothers has expanded due to later expansions in coverage under the ACA...."

Reminder of what the consumption data is,

"...Our analyses primarily use consumption data from the Consumer Expenditure (CE) Interview Survey. The CE is a quarterly survey that provides comprehensive information on family spending for about 7,000 families each quarter (or about 5,000 prior to 1999). We use the surveys from the first quarter of 1984 through the first quarter of 2020. Surveys are administered throughout the three months of a quarter, and questions about expenditures typically have a reference period of the three months preceding the interview month. For each observation we specify the reference year as the year in which the majority of reference months fall. Our main analysis sample from the CE includes families headed by a single woman aged 18-54 who lives with her own children only and at least one child is under the age of 18, which excludes single mother headed families where other related or unrelated adults are present. We include observations with reference years for spending from 1984 to 2019, a period that spans many years prior to and after the implementation of the major reforms to the social safety net during the 1990s that we highlight...."Note they use PCE.

Comp shift in single mother population

"... There have been substantial changes in the composition of the single mother population over the last four decades. For example, single mothers in the 2010s were more likely to be Hispanic and more likely to attend college than those in1980s...Because our analysis focuses on the effects of tax and welfare reform on consumption growth, we exclude the influence of changes in the demographic composition of the single mother population by holding observable characteristics—age, education, and race/ethnicity of head— constant over time by re-weighting the samples from 1987-2019. Specifically, we first divide our sample from the first period (1984-1986) into 24 demographic cells defined by three variables: age (18-34, 35-54), education (high school dropout, high school degree, some college, College degree or above), and race/ethnicity (non-Hispanic White, non-Hispanic other race, Hispanic). These cells are defined broadly enough to ensure that none of the periods contain empty cells. We then use the share of the population in each of the 24 demographic cells to adjust the weights to hold constant demographic characteristics....

Changes in Income and Consumption of the Worst Off

"....Before we present our main results for consumption, we consider how income has changed for single mother headed families at different parts of income distribution from 1984 to 2019. Figure 3 shows the percent changes in after-tax income plus food stamps and housing subsidies relative to 1990-92 by income decile using the CPS ASEC. Because small annual samples can result in somewhat noisy estimates, we pool the annual data into 3-year intervals. These results indicate that in the 25 years following welfare reform income for single mothers above the bottom decile rose by 6 to 20 percent, but for those in the bottom decile it fell by 13 percent. Although these analyses use the CPS, in Appendix Figures 1a and 1b, we demonstrate that the results using the CE are broadly consistent with those from the CPS when we use pre-taxincome plus food stamps/SNAP as an income measure, which is defined compatibly in the two surveys..."

"... Figure 4 and Panel A of Table 1 show how consumption has changed for single mothers between 1984 and 2019 relative to the early 1990s for each of the bottom five deciles and the top half of the consumption distribution. These results differ sharply from those for income in two ways. First, unlike the income data indicating declines for single mothers in the bottom decile, consumption data indicate improvements at all deciles. Second, single mothers in the bottom income decile see the greatest decline in income, whereas single mothers in the bottom consumption decile experience the greatest rise in consumption. In particular, consumption for single mothers in the bottom decile rises by 39% between 1990-92 and 2017-19. The degree of consumption growth during this period declines monotonically as we move up the consumption distribution, with consumption in the top half of the distribution rising only by 19%...."

The Consumption, Income, and Well-Being of Single Mother Headed Families 25 Years After Welfare Reform: Comments Image 3

'... Between the early 1990s and 2005- 07, consumption increased by 31% for single mothers in the bottom decile and it increased by 25% for those in the top half. After 2005-07, consumption rose only modestly (by 1-6%) for those in the bottom five deciles, while consumption declined by 5% for those in the top half. In the following section, we consider the extent to which the improved material well-being is due to policy changes, as opposed to changes in macroeconomic conditions, by comparing the patterns of consumption for single mothers to those of other groups that are less likely to be affected by the policies. We verify that these patterns of rising consumption are robust to alternative approaches. For example, we find similar patterns when looking at a measure of total consumption (that includes components that are not well-measured). These results, which are reported in Appendix Figure 2, indicate that consumption for those in the bottom decile rose by 35% between the early 1990s and 2019, as compared to 39% growth for well-measured consumption. For the top half of the distribution, the growth in total consumption during this period is less pronounced (14%) than the growth in well-measured consumption (19%).In results not reported, we also verify that these patterns are not sensitive to how we account for the changing demographic composition of the single mother population over time..."

"... We report changes in median consumption for all three groups of low-educated women and by education for just single mothers (Figure 5). For the low-educated, median consumption rises noticeably for all three groups, but the rise is most pronounced for single mothers (Figure 5a). We also see that consumption rises more for low-educated single mothers than for high educated single mothers (Figure 5b). Between 1990-92 and 2017-19, median consumption rose by 33 percent for low-educated single mothers, while it rose by 17 percent and 24 percent for low-educated single women without children and married mothers, respectively, and by 18 percent for high-educated single mothers.For changes since 1990-92, the rise in consumption for low-educated single mothers is almost always greater than or equal to the rise for the comparison groups in every period. The relative rise in consumption for low-educated single mothers is more muted further down the distribution. At the 25th percentile, consumption rose more for low-educated single mothers than for low-educated single women without children or married mothers (Appendix Figure 3a) or for high educated single mothers (Appendix Figure 3b) over the full period, but for most of the period following welfare reform, growth in consumption is comparable across these groups. Nevertheless, even for this very disadvantaged group of low-educated single mothers, we do not find evidence that changes in welfare policies resulted in a decline in economic wellbeing relative to other groups that were not the target of the reforms. If one looks at total consumption (rather than its well-measured components, which is reported in Figure 5) the rise in relative consumption for single mothers is even more pronounced at the median(Appendix Figure 4) and 25th percentile (Appendix Figure 5)….”

The Consumption, Income, and Well-Being of Single Mother Headed Families 25 Years After Welfare Reform: Comments Image 6

Current explanations for the decline in labor share sum to 3-4 times the actual decline, according to @GeneGrossman @nberpubs.

Do proposed explanations account for the falling labor share of income?

Takeaways by Macro Roundup® AI

Education spending effectiveness confirmed: 92% of multi-state studies (12/13) show significant positive outcome correlation. Meta-analysis validates causal link btw funding and student achievement.

Does increased school spending improve student outcomes?

Takeaways by Macro Roundup® AI

Consumption growth of lowest decile of single mother headed families has outpaced those higher up consumption distribution over the past 25 years, according to @JeehoonHan @nberpubs.

Has consumption grown fastest among the poorest single-mother families?

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Takeaways by Macro Roundup^® AI