Changes in labor income share of China: A micro-level anatomy

China's labor share—the share of labor compensation in national income—has declined since the mid-1990s. However, a turning point occurred in 2008, after which the labor share began to recover. Existing explanations for the shift in labor share of China are primarily developed from either macro- or micro-economic perspectives. Against this backdrop, a new study published in China Economic Quarterly International has bridged the gap between micro and macro levels by analyzing how firm dynamics influence the aggregate labor income share.

Using the Annual Survey of Industrial Firms (1998-2007) and National Tax Survey Database (2008-2016), the study uncovered three micro-level foundations underlying the changes in aggregate labor share in China's manufacturing sector.

First, the aggregate labor share exhibits a trend markedly divergent from that of firms' labor share from 2008 to 2016. "The decline in labor share across all firms partially accounts for the decrease in the aggregate labor share. However, the primary driver of this decline stems from the reallocation of value added toward firms characterized by lower labor share," explains corresponding author Kang Zhou.

Second, the decline in the aggregate labor share over 1998-2007 is not due to firms with high initial market share systematically reducing individual labor share, nor is it caused by firms with low initial individual labor share expanding their market share. "Instead, it's primarily driven by a redistribution effect, where firms gradually reduce individual labor share while simultaneously gaining larger market share," Zhou shares. "Analysis of the post-2008 period indicates that this micro-level mechanism of joint changes in individual labor share and market share persists and applies to different trends in labor share changes."

Third, state-owned enterprises (SOEs) made a significant contribution to the changes in aggregate labor share of the manufacturing sector; from 1998 to 2007 both SOEs and private firms exhibit divergent patterns in aggregate and individual labor share changes. "Further quantitative analysis shows that SOEs account for more than 80% of the changes in the manufacturing sector's aggregate labor share," adds Zhou.

The team's findings offer insights and policy implications, as factor's income share is a key indicator of income inequality. "A declining labor share can lead to an imbalance in income distribution, exacerbating inequality. Additionally, a low labor share would constrain household budget, with reduced consumption then weakening the momentum of sustained economic growth," says Zhou. "Hence, understanding the micro mechanisms driving changes in China's labor share can provide a solid theoretical foundation for policymaking."

The researchers note that further study is warranted. Over the past two decades, China's service sector has experienced significant growth. "The value added of the tertiary industry as a percentage of GDP increased from 41.2% in 2004 to 54.6% in 2023, and the tertiary industry now employs nearly half of China's workforce," says first author Junsen Zhang. "Since this study focuses solely on the manufacturing sector, future research should consider analyzing labor share dynamics within the tertiary sector or across all three sectors, offering richer policy insights."

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Contact the author: Kang Zhou, School of Economics, Zhejiang University, West Quad, 866 Yuhangtang Road, Hangzhou, 310058, kang_zhou@zju.edu.cn.

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