Why have economies become less dependent on labour?

Let’s play a game of Spot the Difference. Below are charts of the labour share of GDP in the 16 largest economies in the world. 13 out of these show the same trend while 3 countries are outliers. Which ones and why are they outliers?

Labour share in the 16 largest economies in the world

Source: Karabarbounis (2024)

The chart is taken from an analysis of the labour share and its drivers by Loukas Karabarbounis and to answer the first question: 13 countries in the sample show a declining labour share over time while three countries show a rising labour share. The three outliers are Brazil, Russia, and the UK.

Now for the second part of the question which is harder to answer. Indeed, neither I nor Lukas have an answer. All we can do is speculate. In the spirit of my extensive rant last week, this means this is not research, but commentary and punditry and simply an observation to make you think, not something to base investments on.

The most likely driver for a declining labour share (though by no means the only one) is technology. If capital is invested in technologies that enhance productivity, businesses can increasingly replace people with machines. I think it is likely that this is a major driving force though it is hard to quantify how big the effect is. But if it is a driver of a declining labour share it says something important about the UK, Brazil and Russia. It says that in these economies businesses either have not invested or not invested enough in technology to keep up with productivity gains in the rest of the world. And that means their growth has increasingly slowed down due to a lack of productivity growth.

Another possible driver is the cost of capital. If the cost of capital increases, businesses will increase the use of labour, if it decreases, they will increase the use of capital and reduce their labour share. In Brazil and Russia cost of capital may have increased (I don’t know) but in the UK, interest rates and the overall cost of capital have declined in lockstep with other industrialised countries like Germany, France, Spain, or Italy, all of which saw their labour share decline. It thus seems unlikely that the rising cost of capital is to blame for the UK experience.

Third, globalisation might have reduced labour share in developed countries because businesses may have outsourced labour-intensive processes to China and other countries. That to me makes intuitive sense (though again I cannot quantify it), especially because we have seen a trend towards a higher labour share in many industrialised countries since the financial crisis 2008. This coincides with gradual global trade decoupling in the same period and thus indicates that there might at least be some truth to it.

Another potential driver is the power of unions and workers in general. If workers lose bargaining power, real wage growth will slow, and workers will see wage gains below the overall growth of the economy. To me, this is also a likely contributor, but I have a hard time thinking about the UK as a country where worker’s bargaining power has not declined. The power of unions today is much diminished compared to the 1980s and likely much lower than in France. Yet France has seen its labour share decline since the 1980s while in the UK it has increased.

Finally, there is the possibility that economies have specialised in different industries and sectors. If a country is specialised in labour intensive manufacturing or services, the labour share of the economy should be higher than for an economy that is more geared toward general manufacturing or services with labour intensity. Again, this driver is unlikely to explain the patterns observed above. Yes, the UK is a country that has a larger share of output from services than Germany, France or Italy, but Brazil and Russia? I never thought about them as service economies. Quite the opposite. Something seems to be amiss here as well.

To conclude, I cannot make rhyme or reason about these patterns except to say that there are probably several factors at work at the same time. But clearly, something has ‘gone wrong’ in the UK compared to the US, Germany, France, etc. and my guess is that is part of the reason why the UK has had a rather poor growth record in the last twenty to thirty years.