The Race Between Preferences and Technology

This paper argues that a unified analysis of consumption and production is required to understand the long-run behavior of the labor share of income in the United States. First, using household data on the universe of consumer spending, I document that higher-income households spend relatively more on labor-intensive goods and services as a share of their total consumption. Interpreted as the result of non-homothetic preferences, this fact implies that economic growth increases the labor share through an income effect. Second, using disaggregated good-level data on factor shares and capital intensities, I estimate that capital and labor are gross substitutes. Consequently, investment-specific technical change, manifesting itself in the form of a well- documented decline in the relative price of equipment capital, reduces the labor share. Given the estimated elasticities, I show that a parsimonious neoclassical model quantitatively matches the observed low-frequency movement in the aggregate labor share since the 1950s, both its relative stability until about 1980 and its decline thereafter. Until the early 1980s, the income effect, working through non-homothetic preferences, offset capital-labor substitution. Subsequently, accelerating investment-specific technical change, leading to increasing substitution of capital for labor, began to dominate the income effect.