Chapter 6 Functional Income Distribution

Labor Income and Property Income (continued)


Inequality in Incomes: Private-sector income by definition this excludes transfer payments, but includes capital gains.


% Total

Quintile Private Sector Income

1986 lowest 1st 1%

2nd 8%

3rd 15%

4th 24%

5th 52%


With the increase in women joining the workforce, we need to look at median family income.

Excellent Publication: Measuring 50 years of Economic Change using the March Current Population Survey (data to 1997)


Current Population Survey prepared annually. Income in the current population survey includes earnings, unemployment, pension & retirement payments, social security, interest, dividends, other income. Does not include capital gains. Analysts also point out that these figures overstate inequality because they do not include food stamps, health benefits, rent-free housing, etc.


% Income from Current Population Survey by Quintile

Quintile 1st 2nd 3rd 4th 5th Top 5%


1967 4.0 10.8 17.3 24.2 43.8 17.5

1977 4.4 10.3 17.0 24.8 43.6 16.1

1987 3.8 9.6 16.1 24.3 46.2 18.2

1997 3.6 8.9 15.0 23.2 49.4 21.7

2001 3.5 8.7 14.6 23.0 50.1 22.4


The concentration of income seems to have peaked in 1993 and has been unchanged since then.


Wealth is more unevenly distributed than income.


Latest wealth distribution figures 1998:


% Population Cumulative % Cumulative Wealth % Stock Owned

Top 0.5% 0.5% 25.6% 37.0

Next 0.5% 1.0% 34.0% 47.7

Next 4.0% 5.0% 57.4% 74.9

Next 5.0% 10.0% 68.8% 86.2


The distribution of wealth is only slightly less concentrated than in 1983, and the major cause of this reduction is the increase in home ownership and home prices. The high concentration of stock ownership in a few persons may explain why the huge decline in the stock market has not yet had a profound effect on the US business cycle.




Long-term Changes in US Economy Related to Labor Income


  1. Monopoly pricing power has continued to increase at least until very recently -- I am not as sure of this in the 1990s with globalization. Both the increase in monopoly power and globally competitive pricing are used as arguments for the weakening of relative labor rates.


  1. Trade unions have steadily declined in influence since 1950s.


  1. Financial innovations and de-regulation have led to wider swings in the business cycle and more severe financial crises for US corporations (until 1990s, maybe continuing with derivatives).



  1. Govt military spending was high % GDP in 1960s and 1970s, lower in 2nd half 1980s and 1990s and now may be growing again (Homeland security and anti-terrorism).


  1. US economy accounts for less of world economy, and imports from lower wage countries are growing.


  1. The shift to service sectors may make the growth in productivity appear lower since we do not have effective productivity measurements in many of the service sectors.



Results of Long term Changes:


  1. Declining rate of growth of productivity in expansions and actual declines of productivity in contractions. 1980s more severe downturns resulted in less investment.


Reversed in 1990s, also as a result of increased investment in equipment and software.

Average Annual Increase in Productivity

1971-1975                  2.36

1976-1980                  1.16

1981-1985                  1.72

1986-1990                  1.32

1991-1995                  1.52 productivity began to increase again in 1990s

1996-2000 2.48 A huge jump! Average y/y%

Show productivity worksheet.


  1. Much higher rates of unemployment in the 1970s and early 1980s. Has been declining since. Actually peaked in 1982 and has been down since.

Show unemployment worksheet


  1. Much lower rates of capacity utilization in contractions of 1970s, 1980s and 1990s but mfg in US is now dominated by information technology where obsolescence is a problem.


  1. Very low inflation 1950s early 1960s, high inflation in 1966-1982 (tends to hold down real wages increases), declining inflation 1982-2001.

Show real wages worksheet.


  1. Inequality has been increasing up to 1993 seems to have flattened out since then.


  1. More severe contractions 1966-1991:
    1. 1966-1991
    2. very minor contractions since 1991.
  2. Effective demand strong until mid-1960s, demand has been very cyclical since 1960s


  1. Wages, salaries and fringe benefits do not move the same. Salaries and fringe benefits move differently and are dominated by their growth rates.



Problems with Data:


  1. Property income may be under reported
    1. hard to document
    2. tax loopholes for corporate property income.


  1. Employee compensation includes many fringe benefits that may be property income. Big accounting issue now with stock options, (probably should be property income).


  1. There is a long-term bias to more employees and fewer entrepreneurs.


  1. Productivity in the service sector is very difficult to measure. Since service is becoming a larger part of economy this is a problem. However, this mostly effects long-term studies. Cyclical patterns s/b not much impacted.




Definitions: We will be talking about all variables in real terms, so we will use the lower case for the variable definitions.


includes wages, salaries, bonuses, fringe benefits and commissions

includes proprietors income, corporate profits, rent and interest



Two Forms of Labor Share Equations:







Cyclical Discussion:

Figures 5.4 and 6.1. We are working with w/y + p/y = 1 form of equation.

Real Labor Income


Fig 6.2 We are working with the w/y = (w/n) / (y/n) form of the equation.


Question: Why would real hourly wages begin to rise in the late stages of contraction?


         These downturns were not severe.

         The effects of inflation on real hourly wages.



Fig. 6.3 Cyclical Behavior of Unemployment and Capacity Utilization.


The only surprising points are 1. that the unemployment goes up much faster in contraction than it goes down in expansion and 2. capacity utilization went down in contraction faster than it went up in expansions. Both of these are due to the long-term trend to higher unemployment and less capacity utilization during this period (1970-1991).










4 Hypothesis as Explanations of the Cyclical Behavior of Labor Share and Related Factors


1.       Wage lag hypothesis -- Real wages lag real national income in both expansions and contractions so the labor share falls in expansions and rises in contractions. There are two parts to this hypothesis:


         Institutions and relations in our private enterprise economy make it difficult for real wages to keep up with productivity increases in an expansion, but it is easier to maintain real wages when productivity is falling. Productivity rises faster in an expansion than hourly wages so the labor share declines in expansions. Productivity declines faster than wages in a contraction so the share of labor rises in a contraction.


Put in forms of our equation: w/y = (w/n)/(y/n)


Institutional and Relational



         Wage lag theory emphasizes affect of output and capacity utilization on productivity. In expansions more capacity is used, productivity rises and labor share declines. In contractions, less capacity is used, productivity declines and labor share rises.

         Labor share = output

         Labor share = capacity utilization


  1. Overhead labor hypothesis -- In early expansion, employers do not need to add proportionately (to output) as many overhead workers. So productivity rises rapidly in early expansion. In early contraction, companies cannot reduce proportionately (to output) the number overhead workers so productivity declines rapidly. Of course, use w/y = (w/n)/(y/n) to derive labor share. This hypothesis supports the the same conclusions as the wage-lag hypothesis concerning capacity utilization and output versus labor share.


Definition -- Overhead includes all the workers activities that contribute to production but are not direct labor.


  1. Unemployment hypothesis This hypothesis states that:

    1. The level of unemployment determines employee and employer relative bargaining power, which will determine both wage levels and productivity (and, therefore, labor share)
    2. There may be a relatively long lag time between changes in unemployment and changes in the labor share.


As an expansion continues, unemployment declines, employee bargaining power increases (it is easier for employees to find equivalent new jobs and it is difficult for employers to find qualified new employees). Therefore, the rate of increase in productivity declines and real labor rates rise resulting in rising labor share.


As a contraction continues, unemployment rises, employee bargaining power declines (it is easier for employers to find qualified new employees and it is difficult for employees to find equivalent new jobs). Therefore, the rate of increase in productivity increases and real labor rates decline resulting in the labor share declining.

However, the labor share does not increase (or decline) over the entire expansion (or contraction). We have seen this empirically. The unemployment hypothesis postulate a lag effect so that the labor share rises only in late expansion, and the labor share declines only in late contraction. Employees remember the recession during the first half of the expansion, and they remember the boom in the first half of the contraction. Ray Boddy, at SDSU, is a leading unemployment hypothesis theorist.


Labor share as unemployment

Labor share as unemployment

With a time lag.


Empirically, the unemployment hypothesis does not well over business cycles (the short-term). We do not always see an increase in the labor share in the second half of an expansion. The unemployment hypothesis test much better over the long-term.


  1. Synthetic hypothesis This hypothesis puts together the wage-lag hypothesis (at least the capacity utilization part of it) and the unemployment hypothesis. The labor share is a function of both unemployment and capacity utilization. Both of these influences are exerting pressures in all the cycle phases, but the relative importance of each changes over the cycle phases.


Labor share = w/y = w/y1(capacity utilization) + w/y2(unemployment)


Unemployment acts with a significant time lag. Note the pattern that emerges. Unemployment acts in the late stages of both expansion and contraction, and acts in the opposite direction of the capacity utilization.


Lets summarize these influences by cycle phase (we will have to understand all the factors and how they interact):



         capacity utilization rises rapidly

         productivity rises rapidly (part because of technology, but mostly because of better capacity utilization and more absorption of overhead)

         nominal and real wage rates rise but more slowly than productivity (because wage contracts are fixed at old levels)

         unemployment is declining but has no immediate effect (it has not had time to act -- the time lag issue).

         therefore, the labor share declines.



         capacity utilization is now rising much more slowly

         productivity is rising much more slowly (because of a better bargaining position for labor and the easy gains from overhead absorption have been made)

         nominal wages are increasing, sluggishly, because labors bargaining power is increasing, but real rates may slowly increase or even decline as inflation may be rising

         unemployment is declining more rapidly -- unemployment has had time to act with its time lag

         therefore, the labor share is relatively stagnant or may even begin to rise


Crisis (Early Contraction):

         capacity utilization is now falling

         productivity is rapidly declining (probably because employers are trying to hold on to skilled labor despite the downturn and overhead absorption drops)

         nominal and real wage rates do not decline because of contracts and labors resistance to wage cuts

         unemployment is rising (but has not had time to act the time lag issue). therefore, the labor share rises rapidly


Depression (Late Contraction):




The empirical results summarized on page 127 are typical of econometric tests. The statistical significance of a particular variable often depends on the group of variables being tested. You must have sound theory to guide the setup of the statistical test.