Rognlie: Deciphering the Fall and Rise in the Net Capital Share (2015)

The Point: Rognlie starts by highlighting the link between recent discussions on inequality and the area of macroeconomic research dealing with capital and labor shares of income.

Piketty, for example, argues that the high concentration of capital in the hands of a few, and returns on capital, which exceed the overall growth rate of an economy will exacerbate inequality. Economists including Atkinson, Piketty, and Saez have pointed in their work to a rising share of capital income beginning in the 1970s and worry about the consequences if this trend continues its upward trajectory.

In his paper, Rognlie takes a closer look at the historic trends of the capital share of income. He deconstructs capital into its various forms and considers the trends in capital in the form of real estate versus other types of assets. He also reiterates the importance of making a clear distinction between gross capital income and net capital income (gross capital income minus depreciation).

Rognlie points out that the rising share of capital beginning in the 1970s is really following a U-shaped trajectory. The net capital share of income dropped precipitously in the mid-to-late sixties before beginning a rebound in the mid-seventies. On top of that, Rognlie finds that most of the increase in the returns to capital has been driven by the housing sector. Meanwhile, the capital share of income derived from other types of capital have only returned to their previous level. This is relevant to discussions about inequality, because, as Rognlie points out,"housing has relatively broad ownership, it does not conform to the traditional story of labor versus capital, nor can its growth be easily explained with many of the stories commonly proposed for the income split elsewhere in the economy—the bargaining power of labor, the growing role of technology, and so on." (11)

The Quotes: "The notion of a “labor” or “capital” share is not monolithic; there are several ways to define and measure these concepts, and different choices can lead to strikingly different interpretations of the data." (4)

"Relative to the existing literature, this paper makes several contributions. First, it argues that as a purely descriptive matter, the recent behavior of income shares is widely misunderstood: rather than experiencing a steady rise, the net capital share for large developed economies has followed a U-shaped trajectory in the postwar era, and its longterm expansion originates entirely in the housing sector...Second, this paper observes that when net capital income outside the housing sector is disaggregated between the return on fixed assets and a residual share of pure profits, the U-shaped trajectory is driven mainly by the residual... Finally, it describes the theory of factor shares and the role of elasticities of substitution, evaluating various hypotheses by performing counterfactual simulations in a multi-sector model." (3)

"Figures 1 and 2 report the average net and gross capital shares, respectively. As figure 1 demonstrates, the postwar behavior of the net capital share is characterized not so much by a secular rise as by a precipitous fall in the 1970s, which preceded a steady rebound... Set against figure 1, figure 2 reveals that there is a remarkable difference between the long-run behavior of net and gross shares, echoing the results of Bridgman (2014): since average depreciation as a share of gross value added has risen, the gross capital share displays much more of a long-term upward trend. Crucially, much of this disparity emerges before the 1970s... As argued in section 2.1, net shares are likely most relevant for discussions of distribution and inequality. Still, figure 1 paints a perhaps ambiguous picture of the net capital share: the recent rise might be in part just a recovery from the anomalously low levels of the 1970s, but the capital share is now reaching and even surpassing the heights previously achieved in the 1950s and 60s. To what extent, then, is the current high share of capital income a truly novel phenomenon? This question is best addressed by disaggregating further along an important dimension, distinguishing between capital income from housing and capital income from the rest of the economy." (9-10)

The Author: Matthew Rognlie is a Ph.D. student at the Massachusetts Institute of Technology. This paper started as a comment on the blog Marginal Revolution, and eventually grew into a full length paper, which Rognlie presented at the Brookings Institute in March 2015.

The paper can be found here.

Citation: Rognlie, Matthew. Deciphering the Fall and Rise in the Net Capital Share. Brookings Papers on Economic Activity. March 2015.

* Figure 1 from Rognlie's paper shows a U-Shaped trend for the average net capital share of countries in the G7.