Imagine the proceeds of economic output as a pie, crudely divided between the wages earned by workers and the returns accrued to the owners of capital, whether as profits, rents or interest income.
Until the early 1980s, the relative sizes of those slices were so stable that their constancy became an economic rule of thumb. Much of modern macroeconomics simply assumes the shares remain the same. That stability provides the link between productivity and prosperity. If workers always get the same slice of the economic pie, then an improvement in their average productivity — which boosts growth — should translate into higher average earnings.
More recently, however, economics textbooks have been almost the only places where labor's share of national income remains constant. Over the past 30 years, workers' take from the pie has shrunk across the globe.
In America, workers' wages used to make up almost 70 percent of GDP; now the figure is 64 percent, according to the OECD. But some of the biggest declines have been in egalitarian societies such as Norway (where labor's share has fallen from 64 percent in 1980 to 55 percent now) and Sweden (down from 74 percent in 1980 to 65 percent now). A drop has also occurred in many emerging markets, particularly in Asia.
The scale and breadth of this squeeze are striking. And the consequences are ugly. Since capital tends to be owned by richer households, a rising share of national income going to capital worsens inequality. In countries where the gap in wages between high earners and the rest has also increased, the two effects compound each other. In America, the share of national income going to the bottom 99 percent of workers has fallen from 60 percent before the 1980s to 50 percent.
When growth is sluggish, as it is now, these shifts mean that most workers are getting a smaller morsel of a smaller slice of a slow-growing pie.
Politically, that is dangerous, and it is producing a predictably polarized debate. The left blames fat-cat firms and the weakness of unions for workers' declining share. Those on the right, if they acknowledge a problem at all, argue that the fault lies with big government and high taxes.
All these explanations are hard to square with the fact that the shrinkage in labor's share of the pie has occurred in so many countries, with widely differing levels of unionization and sizes of government. Indeed, studies comparing the trends in different countries' labor markets suggest that the sorts of things politicians argue about, from corporate-governance rules to trade-union laws, are not what really count here.
Bigger global forces seem to be at work. Innovation, especially in information technology, has dramatically increased the wages of workers with the skills to harness it, while hitting others. It has also squeezed labor's overall share of the pie, as firms substitute ever-cheaper machines for less-skilled workers. Some economists also emphasize the role of globalization, especially trade with China, in adding to the pinch.
All this points to the sorts of things policymakers can do to help. They should focus on improving the prospects of the low-paid and low-skilled. And they should aim to spread capital's gains more widely.
The goal should be to strengthen workers without hamstringing firms. Growth, rather than employment protection, is the priority. More work means a stronger labor market, which would bid up employees' slice, as it did in America in the 1990s when unemployment was at record lows.
But even in a growing economy a worker competing with a machine can lose out. So education and training need a reboot, too: a greater emphasis on technical subjects, from math to mechanics, would help ensure that more workers are not replaced by machines but design and operate them.
Other sensible reforms may seem counterintuitive. A cut in corporate tax rates is one. Combined with a narrowing of the difference between tax rates on individuals' income from capital and from labor (which is often more heavily taxed), the result would be a more efficient system that promoted economic growth, and thus jobs. Policymakers could also think more creatively about broadening capital ownership, whether through pension reform or more privatization.
Paradoxical as it may sound, a good antidote to labor's falling share of national income would be to boost ordinary workers' share of capital.
Copyright 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.