The Neoclassical Growth Model and the Labor Share Decline

Area of Science:

• Economics
• Macroeconomic Modeling

Background:

• The labor share of income is declining in empirical data.
• Neoclassical growth models (NGM) commonly assume a constant labor share.

Purpose of the Study:

• To quantitatively assess the impact of the discrepancy between declining empirical labor shares and constant labor shares assumed in NGM.
• To compare the performance of NGM calibrated with constant versus declining labor shares.

Main Methods:

• Comparing alternative calibration approaches for NGM with constant and declining labor shares.
• Analyzing general equilibrium effects on wage growth and macro aggregates.
• Conducting robustness checks with a CES production function, different time periods, and varying labor share calculations.

Main Results:

• Little difference in model performance was found between calibration approaches.
• General equilibrium effects, particularly the investment response, offset the mechanical wage reduction from a declining labor share.
• Different model specifications yield nearly identical paths for macro aggregates.

Conclusions:

• The assumption of a constant labor share in NGM remains appropriate for studying many standard macro aggregates.
• The discrepancy between data and model assumptions has limited quantitative importance for aggregate outcomes.