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Does Capital-Labor Substitution or Do Institutions Explain Declining Labor Shares

Daniel Berkowitz ()

No 6060, Working Paper from Department of Economics, University of Pittsburgh

Abstract: Labor shares have been declining around the world since the 1980s and there are severalexplanations for this. Karabarbounis and Neiman (2014) highlight the role of a high substi-tutability between capital and labor that enables firms to easily replace labor with capital asthe rental-wage ratio falls. However, Acemoglu and Robinson (2015) argue that political factorsshaping the evolution of institutions can be more important than the automation of productionprocesses. Using firm-level data from China, we study the relative importance of capital-laborsubstitution and institutional changes. To account for firm-level heterogeneity, we examine theevolution of labor-share distributions during 1998-2007. We find that labor market reforms inthe state sector and product market de-regulation that smoothed the way for the rapid growthof the private sector can explain the majority of the decline in labor shares. Our results forChina are consistent with the findings in Autor et al (2017) for the United States that theemergence of "superstar" firms that are large, have high markups and low labor shares drivedeclining labor shares.

Date: 2017-01
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