Abstract

THE ROLE OF FINANCIAL CONSTRAINTS ON LABOUR SHARE DEVELOPMENTS: MACRO- AND MICRO-LEVEL EVIDENCE

Elena Crivellaro

 Organization for Economic Co-operation and Development

Aikaterini Karadimitropoulou

Bank of Greece and University of East Anglia

Abstract

Technological advancements have been affecting labour shares through a steep decline in the relative price of investment goods. This has lowered the cost of capital allowing firms to replace labour with capital. Nonetheless, financing obstacles could obstruct investment in both labour and capital. This paper assesses the role of financial constraints in hampering the effect of relative investment prices change on labour shares, using data for up to 26 OECD countries over the period 1995-2014. We find statistically significant, economically large and robust effects of financial constraints acting as a channel to hinder the effect of relative investment prices changes on labour shares. In particular, our results reveal that: (i) there has been a global decline in the labour share that coincides with declines in the relative price of investment goods and this decline has been heterogeneous across countries with different levels of financial constraints; (ii) industries highly dependent on external finance face a lower decline in the labour share following a drop in the relative investment price than industries that are less dependent on external finance, possibly because they are more constrained in accessing funds to finance investment; (iii) industry-level investment prices affect the labour share partly through changes within-firms rather than through composition effects, with smaller effects for firms that are more dependent on external finance and larger effects in less financially constrained and highly productive firms. These results are corroborated by an estimated aggregate elasticity of substitution between capital and labour greater than one, and higher for countries that are less financially constrained.

Keywords: Labour Income Share, Financial Constraints, External Financial Dependence, Relative investment price

JEL Classification: E25, E44, O33, J21

Acknowledgements: We are grateful to Loukas Karabarbounis for discussions, guidance and feedback on the current and earlier versions of the paper. We are also thankful to Stephen Davies, Romain Duval, Heather Gibson, Miguel León-Ledesma for their feedback and comments. We also thank participants at seminars in the OECD, the University of East Anglia, the FED of St Louis Workshop "Applied Time Series Econometrics Workshop", the "22nd International Conference on Macroeconomic Analysis and International Finance", the "14th Biennial Conference of the Athenian Policy", and "the 17th Conference on Research on Economic Theory and Econometrics" for useful comments and helpful discussions. All errors are our own. This project has received funding from the European Union's Horizon 2020 research and innovation programme under grant agreement number – 746100 – GaSLS.

Correspondence:

Aikaterini Karadimitropoulou

Bank of Greece

21 E. Venizelos Avenue

102 50 Athens