2. Trends in the labor income share and basic drivers of the change

As summarized by Brada [2] and Young and Tackett [3], we find that labor income shares of world economies have shown a downward trend since the 1980s (especially since the 1990s), and this decline trend is shared by developed and developing countries equally. This chapter focuses on the period from 1995 to 2011 for which related data are available. The ratio of labor income share in 2011 to that in 1995 for developed countries (32 OECD countries) is 0.956 on average, and 0.932 for 23 developing countries (data source is Penn World Table Ver.9.0).

Theoretically, the key parameters that influence the factor shares of income are the elasticity of substitution between capital and labor, the accumulation of production factors, and labor- and capital-augmenting technology or directed technological changes [4]. If capital and labor are gross complements, as most empirical evidence suggests, and if the directed technological changes are not taken into account, then the labor income share increases as long as a relative cost of capital to labor decreases, as would be the case in many economies. However, this is not reality. The evolution of income shares thus depends especially on the above two factors: factor-augmenting technological changes and the rate of capital deepening. According to Alvarez-Cuadrado et al. [5], the basic theoretical overview is as follows.

Assuming that the elasticity of substitution within each sector is constant, the output for sector i is produced using the production function

globalization (the expansion of international trade and capital flows), technological change, capital deepening (the amount of real capital present in relation to labor increases), product and labor market institutions, and the bargaining power of labor, among others. This chapter focuses on the global value chains (GVCs) as an important determinant of changes in the labor income share and indicates the mechanism responsible for the share decline under GVCs, which has never been documented in prior studies. We analyze the mechanism by measuring

The important point is that the amount of services input for nonservices production increases in developing countries where the nonservices production has started to be conducted by multinational enterprises (MNEs) from developed countries in GVCs. As a result, the services sector in developing countries actively accumulates capital to supply quality services to the nonservices sector effectively while the nonservices sector also promotes capital accumulation under severe international competition. The consequent macro-based capital deepening decreases labor income share in developing countries. In developed countries, on the other hand, many tasks of the nonservices sector with low elasticity of substitution between capital and labor are offshored to developing countries and the remaining nonservices sectors with relatively high elasticity of substitution accumulate capital at a rapid pace in an environment of

This mechanism of worldwide labor share changes can be analyzed by utilizing the data of sectoral labor income shares of developing and developed countries. Preceding studies have rarely used this kind of comprehensive dataset and rarely discussed intersectoral linkages between services and nonservices sectors as important determinants of the changes in macro-

As summarized by Brada [2] and Young and Tackett [3], we find that labor income shares of world economies have shown a downward trend since the 1980s (especially since the 1990s), and this decline trend is shared by developed and developing countries equally. This chapter focuses on the period from 1995 to 2011 for which related data are available. The ratio of labor income share in 2011 to that in 1995 for developed countries (32 OECD countries) is 0.956 on average, and 0.932 for 23 developing countries (data source is Penn World Table Ver.9.0).

Theoretically, the key parameters that influence the factor shares of income are the elasticity of substitution between capital and labor, the accumulation of production factors, and labor- and capital-augmenting technology or directed technological changes [4]. If capital and labor are gross complements, as most empirical evidence suggests, and if the directed technological changes are not taken into account, then the labor income share increases as long as a relative cost of capital to labor decreases, as would be the case in many economies. However, this is not reality. The evolution of income shares thus depends especially on the above two factors: factor-augmenting technological changes and the rate of capital deepening. According to

Alvarez-Cuadrado et al. [5], the basic theoretical overview is as follows.

2. Trends in the labor income share and basic drivers of the change

the labor income share at the sectoral level in developing and developed countries.

low local relative cost of capital.

24 Globalization

economic labor income shares in developing countries.

$$Y\_{it} = \left[ \alpha\_i (B\_{it} K\_{it})^{\frac{\sigma\_i - 1}{\sigma\_i}} + (1 - \alpha\_i) (A\_{it} L\_{it})^{\frac{\sigma\_i - 1}{\sigma\_i}} \right]^{\frac{\sigma\_i}{\sigma\_i - 1}} \tag{1}$$

where α<sup>i</sup> governs the relative importance of the two inputs, Kit and Lit are capital and labor used in sector i at time t, and σ<sup>i</sup> is the elasticity of substitution between these two inputs. Ait and Bit are the levels of labor- and capital-augmenting productivity, respectively. With this production function, the ratio of the factor income shares in sector i is given by

$$\frac{KIS\_{it}}{LIS\_{it}} = \frac{\alpha\_i}{1 - \alpha\_i} \left( \frac{B\_{it}}{A\_{it}} \frac{K\_{it}}{L\_{it}} \right)^{\frac{\sigma\_i - 1}{\sigma\_i}} \tag{2}$$

if the factor markets are competitive and firms choose inputs optimally. Here, KISit and LISit represent the capital and labor income shares, respectively, in sector i at time t.

The bias of technical change is given by g Bð Þ it=Ait , where gðÞ denotes a growth rate. If the bias is positive (negative), technical change is labor-biased (capital-biased) in the sense that it increases (decreases) the marginal product of labor (W) relative to that of capital (R) as indicated from Eq. (3).

$$\frac{R}{W} = \frac{\alpha\_i}{1 - \alpha\_i} \left(\frac{K\_{it}}{L\_{it}}\right)^{-\frac{1}{\sigma\_i}} \left(\frac{B\_{it}}{A\_{it}}\right)^{\frac{\sigma\_i - 1}{\sigma\_i}} \tag{3}$$

The expression of Eq. (2) is potentially consistent with observed trends: if capital and labor are gross complements, that is, σ<sup>i</sup> < 1 as most empirical evidence suggests, then the labor income share in sector i decreases as long as technical change in that sector is sufficiently capital-biased relative to the rate of capital accumulation, that is, g Bð Þ it=Ait < 0 < g Kð Þ it=Lit and the absolute value of g Bð Þ it=Ait is larger than that of g Kð Þ it=Lit .

As Acemoglu [4] has noted, from about the 1980s, when the labor share started a decline, the capital-augmenting technical change has dominated the labor-augmenting technical change. Using this theory and empirical evidence, one could predict that the high growth rate of capital accumulation coupled with capital-augmenting technical improvement may contribute to a downward trend of the worldwide labor income share.

Economic global integration, in terms of trade, finance, and international fragmentation of production, is widely viewed as a significant determinant of the evolution of labor shares. How is this global integration related to the abovementioned theoretical framework of the labor income share?

The Heckscher-Ohlin model predicts that trade integration will lead labor-abundant developing economies to specialize in the production of labor-intensive goods, leading to a rise in the labor income share in developing countries and a decrease of the share in developed countries. This model is at odds with the decline in labor shares of developing economies.

Financial integration, on the other hand, may play a major role in the evolution of the labor income share. Dao et al. [6] describe two distinct channels through which labor income share declines. First, capital mobility lowers labor's bargaining power. This is because globalization has made capital much more mobile internationally, while labor remains trapped behind national borders. The greater international mobility of capital has reduced the bargaining power of workers and increased that of the owners of capital. Second, financial integration lowers the cost of capital in capital-scarce countries, facilitating capital deepening and inducing greater substitution of capital for labor.

The economic globalization-based explanation for falling labor shares in developing countries thus rests on the relative size of the impact that trade and capital flows have on labor shares because increases in trade between developed and developing countries would increase labor income shares in the developing countries.

Financial integration includes two important capital flows: portfolio investment and foreign direct investment (FDI). Between them, FDI is closely related to the GVCs organized by MNEs that have been actively investing in developing countries through international fragmentation of production since the 1990s. The relation between labor income shares and international fragmentation of production through GVCs is discussed in detail in the next section.

To assess the contribution of these globalization factors to the evolutions of labor income shares, we present some stylized evidence of the relation between them (Figures 1–3). In the following analyses, the growth rates of two different variables are compared in each figure because the main objective of this study is to identify the cause of labor income share changes. Moreover, variables used in this study, such as economic globalization, labor income share, capital deepening, and intersectoral production linkages, show that most variations are seen not over time but across countries and industries (fixed effects attributable to countries and

industries). Thus, it is reasonable to compare growth rates of these variables to detect causal

Figure 3. Changes in the external assets and liabilities GDP ratio (x-axis) and changes in labor income share (y-axis) for

Figure 2. Changes in import GDP ratio (x-axis) and changes in labor income share (y-axis) for developed and developing

The Declining Labor Income Shares Revisited: Intersectoral Production Linkage in Global Value Chains

http://dx.doi.org/10.5772/intechopen.81316

27

Figure 1 illustrates the relation between changes in export GDP ratios (horizontal axis, gross rate between 1995 and 2011) and changes in labor income share (vertical axis, gross rate between 1995 and 2011) for 55 countries. These 55 countries include 32 developed and 23 developing countries. We can find significant negative relation between the two variables in

relationships. The available data cover the years 1995–2011.

developed and developing countries.

countries.

Figure 1. Changes in export GDP ratio (x-axis) and changes in labor income share (y-axis) for developed and developing countries.

The Declining Labor Income Shares Revisited: Intersectoral Production Linkage in Global Value Chains http://dx.doi.org/10.5772/intechopen.81316 27

Financial integration, on the other hand, may play a major role in the evolution of the labor income share. Dao et al. [6] describe two distinct channels through which labor income share declines. First, capital mobility lowers labor's bargaining power. This is because globalization has made capital much more mobile internationally, while labor remains trapped behind national borders. The greater international mobility of capital has reduced the bargaining power of workers and increased that of the owners of capital. Second, financial integration lowers the cost of capital in capital-scarce countries, facilitating capital deepening and induc-

The economic globalization-based explanation for falling labor shares in developing countries thus rests on the relative size of the impact that trade and capital flows have on labor shares because increases in trade between developed and developing countries would increase labor

Financial integration includes two important capital flows: portfolio investment and foreign direct investment (FDI). Between them, FDI is closely related to the GVCs organized by MNEs that have been actively investing in developing countries through international fragmentation of production since the 1990s. The relation between labor income shares and international

To assess the contribution of these globalization factors to the evolutions of labor income shares, we present some stylized evidence of the relation between them (Figures 1–3). In the following analyses, the growth rates of two different variables are compared in each figure because the main objective of this study is to identify the cause of labor income share changes. Moreover, variables used in this study, such as economic globalization, labor income share, capital deepening, and intersectoral production linkages, show that most variations are seen not over time but across countries and industries (fixed effects attributable to countries and

Figure 1. Changes in export GDP ratio (x-axis) and changes in labor income share (y-axis) for developed and developing

fragmentation of production through GVCs is discussed in detail in the next section.

ing greater substitution of capital for labor.

26 Globalization

income shares in the developing countries.

countries.

Figure 2. Changes in import GDP ratio (x-axis) and changes in labor income share (y-axis) for developed and developing countries.

Figure 3. Changes in the external assets and liabilities GDP ratio (x-axis) and changes in labor income share (y-axis) for developed and developing countries.

industries). Thus, it is reasonable to compare growth rates of these variables to detect causal relationships. The available data cover the years 1995–2011.

Figure 1 illustrates the relation between changes in export GDP ratios (horizontal axis, gross rate between 1995 and 2011) and changes in labor income share (vertical axis, gross rate between 1995 and 2011) for 55 countries. These 55 countries include 32 developed and 23 developing countries. We can find significant negative relation between the two variables in developed countries; however, we cannot find any relation in the case of developing countries. The same conclusion is obtained in Figure 2, which compares the import GDP ratio and labor income share changes.

Figure 3 indicates the relation between the external assets and liabilities GDP ratio (financial globalization index) and labor income share in the same manner as in Figures 1 and 2 (data source is [7]). In this case, we cannot find any significant relationship. These three figures are a very simple analysis that just compare one economic globalization-related variable and labor income share. One reason to take such a simple method is that it is difficult to consider these variables as distinct drivers of labor shares. In reality, the effects of these three factors on labor shares cannot be fully isolated. More elaborate studies should be conducted in the future. At this moment, it can be concluded that trade and financial integrations as economic globalization factors do not affect labor income share evolution with the exception of trade (export and import) in developed countries. The negative relation between changes in trade GDP ratios and those in labor income shares is consistent with the prediction of Heckscher-Ohlin model as mentioned earlier in this section.
