Decreasing Hours, the Labor Share, and the Elasticity of Substitution

Abstract

The decline in the labor share has attracted the attention of economists in recent years. Empirical literature has documented that this decline can be explained by the increasing capital intensity of the U.S. economy. This paper proposes a mechanism that accounts for the increasing capital intensity - the slowdown of labor-augmenting technology. Under substitutability of capital and labor, such slowdown induces an increase in the rental rate to wage ratio, thus decreasing the labor share. To asses the empirical validity of this mechanism, I construct a general equilibrium model with a CES production function, a utility function compatible with decreasing hours of work, and use a supply-side system to estimate the model’s parameters. I simulate the solution of the model using the actual series for the exogenous variables and I find that the model can account for between half and almost the full decline, depending on the particular specification considered.