Pay Cuts

The portion of income that goes into workers’ pockets has been declining in the U.S. and many industrialized countries for several decades, but the exact cause has been murky. 

“One reason why parts of America are unhappy despite America’s great wealth is because of this very inequitable distribution of income,” says Professor Ann Harrison, former Haas dean. 

A new study from Harrison is the first to compare the impact of four key factors (technological change, globalization, market power, and intangible assets) across five countries on what economists refer to as “labor share”—the portion of revenue going to workers after accounting for the costs of production. 

Harrison analyzed millions of records from public and private companies in Sweden, France, Hungary, South Korea, and Germany. A statistical analysis concluded that technological innovation had an outsized impact on workers’ share of company income: When the share of revenues spent on research and development goes up by 1%, labor share fell by up to 1.3%. This likely had to do with a blow to workers’ bargaining power, Harrison notes.

 “You can suggest replacing people with machines to keep them from demanding a greater share of the pie,” she says. 

Globalization has also had a significant effect. When the share of sales coming from exports jumped 1%, labor share declined by 0.3%, Harrison found. Again, the culprit is less leverage on the part of workers. 

“In a highly globalized world, firms can threaten to relocate, so they can retain more surplus for capital owners,” she says.

Higher market concentration—as measured by the share of revenue going to the top four or top 20 largest firms in a sector—lowers employment and labor share. “When firms have market power, they tend to restrict supply, push up prices, and not employ as many people,” Harrison says. “If workers have no bargaining power, all that surplus goes to the owners or shareholders of the firm.” 

Addressing falling labor share is key to combating rising inequality and ensuring that economic gains benefit everyone, Harrison says. 

Tariffs are not the solution, she argues, because they can put many people out of work. “They restrict global expansion, so markets are smaller and there are fewer opportunities, even if people who are employed get higher wages,” she says. 

Instead, she advocates for policies that increase market competition, such as breaking up monopolies, and boost the power of workers through collective bargaining, improvements in education, or other strategies. 

While technological innovation and globalization can benefit economies, leaders also need to consider the downside risks—namely lost employment or stagnant wages. “We need to create opportunities to counter these forces,” she says.