Labor Share and Financial Constraint

The fall of labor’s share of GDP many countriesin recent decades is well documented. Existing empirical studies are focusing predominantly on advanced economies and the decrease in the relative cost of capital, which conceals a heterogeneous evolution across developing economies.By exploiting a quasi-experiment policy in China implemented in 2006, we assess a new interpretation of the fall in the labor share on firm-level through the channel of financial constraints. Measuring the real cost of capital requires taking into account not only the price of investment goods but also the financial conditions firms are facing, as the latter significantly affect the ability of firms to substitute capital for labor, especially when firms are facing significant financial constraints. To address the potential policy endogeneity, we match our treated firms with comparisons lying on the other side of the same county border, which makes us able to compare individual firms who share the same labor , product and technological shocks and similar cultural characteristics, but different policy shocks.We find that in the short run, improved internal financing lowers the labor share by 4%. In the long run, better access to finance decreases labor share by 11%