Labor income share and economic fluctuations: A sign-restricted VAR approach

Abstract

A plethora of literature documents the worldwide decline in the labor income share since the 1980s, but relatively little attention is given to the effect of changes in the labor income share on macroeconomic fluctuations. Utilizing a sign-restricted VAR model, this paper studies how changes in the labor income share affect business cycle fluctuations for the US and Korea. In line with the existing literature, I identify two structural shocks impinging on the labor income share—the factor share and technology shocks, which result in different short-run dynamics in the labor income share and real wages. Empirical analyses reveal that, for both countries, the macroeconomic consequences of a rising labor income share hinge upon how real wages respond. In the short run, a higher labor income share accompanied by rising real wages tends to be expansionary, but an increase in the labor income share coinciding with falling real wages results in lower GDP.