A common refrain among economists in recent years is that the fruits of the economy’s success have gone to owners of capital rather than workers, with this growing inequality a major theme of Thomas Pikkety’s wildly popular work.  New research from MIT sets out to understand precisely why the labor share of GDP has fallen from 67% in 1980 to just 59% today.

They believe the key is the growth rates of companies that adopt very different strategies, with those whose investments focus more on capital than workers seeming to enjoy greater success than those whose investments are more people-oriented.

“To understand this phenomenon, you need to understand the reallocation of economic activity across firms,” the researchers say. “That’s our key point.”

Superstar firms

Central to their theory is the outsized success of so called “superstar firms”, whose progress has played a bigger role in the shift than factors such as automation, the growth in international trade, the decline of union power, or outsourcing, as proposed by other economists.

The discontent from economists has mainly arisen due to the remarkable stability of labor’s share of GDP throughout the 20th century.  Indeed, it was something that John Maynard Keynes famously referred to as a miracle.

The researchers analyzed data from across the OECD in manufacturing, wholesale, retail, utilities, services, transportation, and finance sectors, including data on payroll, output, and total employment.

What is clear from the data in these sectors is that a relatively small number of highly competitive firms have dominated each market.  In retail, for instance, the leading four companies had previously accounted for just 15% of sales in 1981, but by 2011 this had mushroomed to 30%.  Similar growth appeared in other industries, whether utilities (29% to 41%) or manufacturing (39% to 44%).

Meanwhile, the payroll-to-sales ratio was also on the decline, with the only exception across all sectors analyzed being finance.  In manufacturing, for instance, the ratio fell from 18% in 1981 to 12% in 2011.

Uneven spread

This decline in labor’s share of GDP is not common across each industry however.  Instead, it’s changing primarily at those businesses that have come to dominate their respective markets, and because those firms are dominating their markets, it’s shifted the entire economy.

This is an important point, as these market dynamics appear to be more important than automation and technological investment, which have widely been blamed for the erosion of workers pay and status in the workplace.

Similarly, the researchers found no real impact of changes in trade policy, and in particular to the impact of globalization on domestic wages, which is equally important as outsourcing and foreign competition have also been widely blamed for declining fortunes for domestic workers.

The researchers are at pains to point out that these leading firms are not exploiting workers per se, and many of them pay above-average wages to ensure they can attract the best and the brightest.  It’s more a case that these firms are able to extract more value from the employees, and these firms have taken an ever larger piece of each market they’re in.

Digital leaders

The authors believe that the success of these leading firms is not because they alone have invested in technology, for their ascendancy coincides with investment in technology across each sector.

“We shouldn’t presume that just because a market is concentrated — with a few leading firms accounting for a large fraction of sales — it’s a market with low productivity and high prices,” they explain. “It might be a market where you have some very productive leading firms.”

Much of the competition that exists is platform specific, which requires a significant investment to create, but once scale has been reached, it’s incredibly hard for competitors to replicate.

Despite this highly defensive position, the authors believe it’s important to distinguish between firms that become “lazy monopolists” who abuse their position to increase prices, or firms who come to dominate their industry through competitive forces.  The current situation, they argue, is largely a result of the latter rather than the former, with innovation happening at a tremendous pace, even in sectors where a small number of firms dominate.

There is no guarantee that this level of investment in innovation will continue, however, nor that the dominant market position of firms won’t ultimately end up being abused.

“Once a firm is that far ahead, there’s potential for abuse,” the researchers say. “Maybe Facebook shouldn’t be allowed to buy all its competitors. Maybe Amazon shouldn’t be both the host of a market and a competitor in that market. This potentially creates regulatory issues we should be looking at. There’s nothing in this paper that says everyone should just take a few years off and not worry about the issue.”

While not the final word on the topic, it does nonetheless add an interesting element to a debate that is likely to rage on for some time to come.