Is capital share declining because mark-ups are rising?

From Simcha Barkai at the University of Chicago (pdf):

This paper shows that the decline in the labor share over the last 30 years was not offset by an increase in the capital share. I calculate payments to capital as the product of the required rate of return on capital and the value of the capital stock. I document a large decline in the capital share and a large increase in the profit share in the U.S. non-financial corporate sector over the last 30 years. I show that the decline in the capital share is robust to many calculations of the required rate of return and is unlikely to be driven by unobserved capital. I interpret these results through the lens of a standard general equilibrium model, and I show that only an increase in markups can generate a simultaneous decline in the shares of both labor and capital. I provide reduced form empirical evidence that an increase in markups plays a significant role in the decline in the labor share. These results suggest that the decline in the shares of labor and capital are due to an increase in markups and call into question the conclusion that the decline in the labor share is an efficient outcome.

For the pointer I thank David Levey.


+1 for all the gutsy use of first person.

Interesting. I'm wondering how this translates into the real world.

Take a US manufacturer of a specific product, a series of manufacturers. An established market, one that is growing a bit faster than the economy. Lots of manufactured products, some large some small, all with at least three major players who compete for business. Over time the whole industry gets bought up by three major corporations, and this industry is a small part of their whole. The manufacturing plants get moved offshore, and the local operations are sales and engineering. Product lines are dropped. Instead of a broad range of products that cover the wide market requirements, it becomes a narrow offering, market segments are simply abandoned. Costs go way down, dramatically so for the products they sell, but markups increase. The old hands who know the industry are gotten rid of. Regulation is their friend; the barriers to entry are insurmountable, natural monopolies are created by limiting choice in the market by any means.

So capital goes down; who needs it. Labor goes down, it is elsewhere. Markup goes up, markup being percentage of the sale above cost.

Inefficient has a meaning in economics, doesn't it? Does it not mean that the bottom hasn't been found yet?

By the way, this is happening in the industry I work in. It is a way of thinking, and these companies really have nothing except cash flow. They are very vulnerable to technological change; they don't make things so don't know how to make new things. What I do is like a sidekick for them; their bread and butter is living off of government. And what I do gets interesting only when government regulation mandates a massive change in practice, even if that means that the market will be substantially smaller. They have no capital to protect by pushing for growth or increased sales, so a smaller market at even higher margins is better for them. But even then they don't have the people who know how to make things work, so they will fail at that as well.

But in the short term the numbers look fabulous.

A company is not the economy. If/when a new product is required it doesn't need to come from existing companies, and also the capital needed to fund the new product doesn't need to come from them as well. In other words if you are in a business that has a stable customer requirement, why would you carry the overhead needed to develop new and better products? Actually I think most companies err on the side of too much R&D for agency reasons. The skill set needed to innovate is very different to the skill set to run a business and very often it is better to separate the two activities completely.

Sure. In an efficient market the holes would be filled very quickly by other players seeing a market opportunity.

The point of this paper is that it isn't an efficient market. The high markups are possible because of lack of competition.

What's the difference between capital share and profit share?

I agree it's confusing, but tt's described on page 5.

In the paper capital is an input of the production process, but profit is paid to shareholders. It's not consistent with definitions previously used in the literature, but it sheds light on an interesting phenomenon.

A better name for capital may then be an aggregation of intermediary products, debt payments, etc. Everything that is not shares (which confusingly, is called "capital" in the banking world).

Basically, the capitalists continue to clean up, after defining capital to mean something different than it's classical use.

I think the author may be distinguishing between total accounting profits and "economic profits," the latter being a subset of the former.

Although accounting recognizes the interest costs of debt capital in the income statement it does not recognize the full costs of equity capital (dividends are rarely sufficient to cover a "full cost of capital" for equity).

So, Barkai creates a full cost of capital (page 5, “2 The Capital Share”):

"I compute a series of capital payments equal to the product of the required rate of return on capital and the value of the capital stock. I find that the required rate of return on capital declines sharply, driven by a large decline in the risk-free rate. "

In Figure 1, “The Required Rate of Return on Capital,” he shows that the required rate of return (including a full charge for the use of equity capital), has dropped from around 17% in the early 1980s to around 10% in 2015. This drop resulted from the decline in the risk-free (Treasury) interest rate over the period.

The profits left over after a charge for the use of equity capital are known variously as “economic profits,” “residual income,” “economic rents,” or “economic value added.”

If the full cost of capital drops from 17% to 10% and all other things remain the same, then the economic profits of the firm will rise.

I think this is what he means when he says that “the capital share” has fallen along with the labor share. Given $x of tangible and intangible assets on corporate balance sheets, the “required” (implicitly, not contractually) rate of return has gone down as per Figure 1.

Is it just another example of Baumol's cost disease as services take up an increasing share of the economy?


Or is it taxes? You want to get your money out of the company. There are three channels. It's either through wages, through interest payments, or through capital gains/dividends. They vary in relative attractiveness with tax policy.

Krugman is writing about these for years:

Could this be caused in part by a failure to adequately account for intangible assets?

Everything else being equal, one would assume that the emergence of giant companies (Google) with few physical assets could alone create this result.

Seems like this like the last two links from Miguel Madeira's post from Krugman ("Profits Without Production" and "Rents and Returns", where 'monopolists' are at play), as well as a hint of Ricardo Hausmann and Federico Sturzenegger's Dark Matter, as Jack says.

BTW these "monopolists" have feet of clay IMO, as fads change.

"This paper shows that the decline in the labor share over the last 30 years was not offset by an increase in the capital share."

A few years back I look at the UK data. Down to four parts- capital and labour shares, mixed income and subsidies and taxes on production/consumption - the classic four parts of the economy in this view.

Capital share was pretty static (after that 70s slump). Labour share down. Mixed income up (more self employed). And taxes on consumption up. VAT came in in 70s and has doubled in rate since then.

The American figures aren't as clear as the allocations of mixed income and tax and subsidies are added to labour/capital before examining changes over time.

That's probably a mistake.

I'm sure sales taxes have risen as a portion of the economy over the decades. That would be consistent with a falling labour share....

David Levy?

The decapitalization of the American economy has been a stunning success. And not only private capital, but public capital as well. Will America turn inward and once again invest, in private capital, in public capital? Like an enormous tanker adrift in the ocean, once its turned there's no quick and easy way to reverse course. As I've commented many times, globalization and trade are entering a new phase, in which China (and others) produce goods for China firms to compete with goods produced for American firms (including goods made in China for American firms); American firms will soon view China as competitor rather than collaborator. Combine that with destination-based corporate tax reform, and domestic investment will be all the rage. And so will China bashing. Be careful what you ask for.

Isn't this old news? How do you think we get craft beer and Whole Foods?

I wonder how she treated a manufacturer who self-sourced components in a foreign country and stated the value of products imported for incorporation in products manufactured in the US.

Doesn't a decline in the shares of labor and capital inputs mean that the share of entrepreneurs has risen? I didn't look at the paper, but it sounds like what it's saying is that company profits have risen, but the return to passive capital providers has not. That makes sense with all the innovation we've seen. It doesn't seem like a bad thing, either. Whoever's getting those profits has been able to get a lot out of the labor and capital inputs they're using.

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