Working Paper: CEPR ID: DP13168
Authors: Monika Merz; Philipp Hergovich
Abstract: The capital-to-labor ratio has steadily risen in the U.S. and elsewhere during the post-WWII period. Since the 1970s this rise has been accompanied by a rise in the level and variability of corporate profits whereas the labor share of income has declined. In this paper we ask whether these trends are related in that they can be explained by a common determinant such as the observed decline in the relative price of new capital goods, or the change in production technology towards increased substitutability between capital and labor. We use a dynamic stochastic equilibrium model of competitive search in the labor market augmented by a CES production function that allows firms to substitute between capital and labor at varying degrees. By assumption, firms can adjust capital more easily than labor. Profits arise from rents paid to quasi-fixed factors of production. We find that the declining relative price of capital and the increase in factor substitutability each causes the capital-to-labor ratio and corporate profits to rise, but only increased factor substitutability generates the observed decrease in the labor share of income and increases the relative variability of profits.
Keywords: factor substitutability; quasi-fixed production factor; competitive search; profits
JEL Codes: E24; G32; J64
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Declining relative price of capital (E22) | Capital-to-labor ratio (D24) |
| Declining relative price of capital (E22) | Corporate profits (D33) |
| Increase in factor substitutability (F16) | Capital-to-labor ratio (D24) |
| Increase in factor substitutability (F16) | Corporate profits (D33) |
| Increase in factor substitutability (F16) | Labor share of income (E25) |