Understanding the Dynamics of the Labor Share: the Role of non-Competitive Factor Prices

In this paper we explore the dynamics of the aggregate labor share for the US economy. We explore the extent to which a family of real business cycles models, where wages are not set competitively (tailored to replicate cyclical facts about the labor market), is capable of generating the observed dynamics of labor share as described in Ríos-Rull and Santaeulalia-Llopis (2007). We build upon Merz (1995), Andolfatto (1996), Langot (1995), and Cheron and Langot (2004), among others, who analyze models where wages are determined via Nash bargaining, employment lags productivity, and labor share falls with productivity innovations. Although these models account for various business cycles properties, they fail in replicating the dynamic empirical response of the labor share to technological shocks; this occurs even after we change preferences and technology. However, changing the aggregate production function (from Cobb-Douglas to CES) delivers the best results, hinting that future research should be directed away from Cobb-Douglas technologies rather than from noncompetitive factor markets.