The Decline in Capital Efficiency and Labour Share

The labor share in the United States historically remained roughly stable, but in this century it significantly decreased.

The journal of the the London School of Economics Economics Department publishes in its last number a paper written by me and Francisco X. Lores (The Decline in Capital Efficiency and Labour Share)  in which we show that the post-war evolution of the labor share can be accurately accounted by the neoclassical growth model with perfect competition and variable and gross complementarity of capital and labor.

We argue that the reason of the decline in the U.S labor share was the strong fall in U.S. capital efficiency which caused a  large drop in the ratio of effective capital to effective labor.

Therefore, our results are opposite to the Piketty's wisdom according to which the decline in the US labor share was due to the increase in the ratio of capital to labor caused by the fast decline of the relative price of investment in an context in which both capital and labor are gross substitutes in production.

We proceed in the following way. First of all:

  • Using KLEMS data, we estimate the elasticity of substitution between capital and labor and we find that it is significantly negative, which means that both productive factors are gross complements.
Using our estimates of the elasticity of substitution, then

  • We calibrate and simulate a neoclassical growth model with a variable elasticity of substitution production function and three types of technological change: labour-augmenting, capital-augmenting and investment-specific. 
In this framework we find that:
  • The decline in US labour share was caused by a large decline in capital efficiency, which led to a decrease in the ratio of effective capital to effective labour.
  • Moreover, the decline in the relative price of investment contributed to reducing the fall in US labour share, while the increase in the economic depreciation rate of US fixed assets accounted for a small reduction in US labour share.