Academic journal article Economic Inquiry

Accounting for the Cyclical Dynamics of Income Shares

Academic journal article Economic Inquiry

Accounting for the Cyclical Dynamics of Income Shares

Article excerpt

I. INTRODUCTION

This paper constructs a framework to quantitatively account for the business cycle dynamics of profits' and labor's share. Despite the evidence in favor of the time-varying behavior of income shares, macroeconomics lacks models that can quantitatively match their time series facts. This article reviews those facts and discusses the inability of existing models to replicate them. It then presents a model and shows that under a careful parameterization, it can quantitatively account for, if not all, many of the properties that describe the behavior of income shares.

Labor's share is defined as the share of national income that accrues to labor. Figure 1 displays the correlation of labor's share with real Gross Domestic Product (GDP) at various leads and lags from 1951 to 2007. (1) Correlations are not strong, the maximum is about 0.50, and the contemporaneous correlation is (significantly) smaller than the correlation between output and the labor's share with a four-period lead. Consequently, labor's share lags real GDP because its correlation coefficient with output is highest after four quarters. Labor's share is countercyclical but very weakly so: the contemporaneous correlation is -0.11, and the 5th percentile for the sample distribution of that correlation is 0.02. (2) On the other hand. Figure 2 shows that the profits' share is strongly pro-cyclical and it neither leads nor lags output; its volatility is about 5.2 times that of output. (3) As perfect competition in labor markets implies a tight link between wages and output, previous studies have deviated from a Walrasian labor market in an attempt to explain these facts. They have done so by specifying contractual arrangements between employers and employees that have broken the link between wages and the marginal product of labor. The goal was to match properties of labor's share over the business cycle. Examples of this line of work include Boldrin and Horvath (1995), Gomme and Greenwood (1995), and Danthine and Donaldson (1992). These authors can only qualitatively match the pro-cyclicality of profits' and the counter-cyclicality of labor's share, but quantitatively their models' results are far from the data.

Dispensing with a Walrasian framework is a characteristic of literature that features search and matching frictions in labor markets, for example, Pissarides (1985). Our research falls within this framework. (4) Although this literature has claimed success in matching some labor market business cycle moments, we show that they cannot account quantitatively for the dynamics of income shares. We link this failure to the typical assumption of free entry of firms, which leads to the asset value of a vacant position to be exactly zero at all frequencies. That free entry implies that the value of a vacant position equals zero can be seen easily from the textbook model of search and matching, for example Pissarides (2000). If it were positive, firms would continue to post vacancies, lowering the probability that a given vacancy gets filled until its present value reached zero.

We construct an environment (5) in which the present value of a vacant position is always positive and endogenously varies over the business cycle. A vacancy has positive asset value because firms need to incur entry costs before they are allowed to post a vacancy, hire workers, and begin production. The equilibrium value of a vacancy is equal to the sunk cost, so that firms are indifferent between entering or staying out of the market. This equilibrium asset value is also time-varying. The reason: entrants rent factors of production to pay for the sunk cost and the efficiency of these factors is affected by the same shocks that generate aggregate fluctuations. As the prices and quantities of these factors vary with aggregate conditions, so do the expenditures that entrants undertake. In equilibrium, these expenditures must equal the capital value of a vacancy. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.