The return of the labor economy

The writer is Chief U.S. Economist at Morgan Stanley

A major economic trend since 2000 has been the sharp decline in labor’s share of corporate income in the United States.

This unprecedented drop marked a break in the fundamental relationship between the real wage after inflation and productivity. While productivity growth continued, real wages stagnated for more than a decade, from 2000 to 2014, spawning a divergence never seen before in recorded data.

The beneficiaries of the falling labor share have been corporations and their owners, with profit margins up nearly 50% from their 1990s level. But the tide is turning and investors should take notice.

Economists as far back as Keynes have commented on the stability of the labor share in historical data. This corresponds to the theory that labor compensation should increase in proportion to productivity gains. Otherwise, competitive markets would lead to a supply of labor by a firm willing to pay higher wages in order to capture the surplus productivity.

Scholars have offered a range of explanations for shifting labor incomes in the United States, including globalization, technological change, market concentration and the rise of superstar firms, and declining bargaining power of workers. .

It is the latter of these theories that is the most compelling, given that the United States is the only developed economy to experience a sharp decline in labor’s share of business revenue during this period.

An accelerating decline in labor market institutions such as unionization, along with a long-term erosion of real minimum wages, has weakened labor in negotiations with capital owners. But around 2015, long before the pandemic hit, things started to change.

The labor share bottomed out in 2014-15, followed by a slow reversal, before rising sharply during the pandemic. Political support and rapid recovery from the pandemic has accelerated the return to old norms.

For fiscal and monetary policy makers, a strong labor market has become a primary policy objective. For example, provisions of the Coronavirus Aid, Relief, and Economic Security Act (also known as the Cares Act) aim to boost labor force participation by easing the financial burden of childcare. Measures taken by the Biden administration to reduce market concentration and strengthen workers’ rights will also be supportive.

Until August 2020, the US Federal Reserve’s mandate to achieve maximum employment revolved around the unemployment rate. It has been redefined as a “broad and inclusive goal” designed to boost labor market tension that reaches the most underserved segments of the workforce.

A strong and inclusive labor market is likely to strengthen the bargaining power of workers. History may ultimately attribute the upward pressure on wages during the pandemic to the Great Renegotiation rather than the Great Resignation.

The Census Bureau predicts that population growth will continue to decline through 2050, which should help keep labor markets tight. Increasing the number of prime-age workers as a share of the overall workforce should also support the worker economy, as companies are forced to align their core values ​​with those of their employees. These fundamental changes support the view that the labor share will continue to reverse its long structural decline.

Evidence of this structural change is mounting. In April, Amazon workers in Staten Island, New York, voted in favor of a union. Apple workers are expected to hold union votes this year. The number of unionized Starbucks stores increased, and the company announced it would invest $1 billion in its employees and stores, including pay raises.

A complete reversal of labor’s income share would dramatically reduce pre-tax margins, with outsized effects on small businesses.

Large companies tend to have more pricing power, and companies with less exposure to labor and more international revenue might also maintain higher profit margins. Domestically focused and highly discretionary sectors such as hospitality, retail, restaurants and leisure stand out as particularly vulnerable.

The prospect of a continued return of the labor share to its historical level implies that wage pressures are not just a temporary phenomenon. Wage growth, fueled by the rapid recovery from the Covid-19 shock, may ease as the economy and labor market falter, but higher wages are here to stay.