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Labor Share Fluctuations in Emerging Markets: The Role of the Cost of Borrowing

One of the stylized facts of growth is that factor income shares remain stable over time. This fact justifi es many economic models using constant income shares. Recently, researchers have been more interested in explaining short-run fluctuations and cyclical movements of labor (income) share. However, the literature has focused on developed markets, predominantly the US, and is silent on labor share fluctuations in emerging markets.

In this paper, I document the volatility and the cyclicality of labor share in emerging markets and show that there is a close relationship between labor share and the interest rate that these countries face in international markets. I then build a model where wages have to be fi nanced through working capital loans and show that the variation in the cost of borrowing can account for the movements of the labor share over the cycle. The premise of the paper is that financing matters to labor share, and that emerging markets serve us a good natural experiment due to the nancial problems and the different features of the interest rate that they face.

Figure-1 illustrates the characteristics of labor share fluctuations in both emerging and developed markets. Labor share tends to be procyclical with output in emerging markets whereas it is slightly countercyclical in developed markets. In addition, labor share is much more volatile in low income countries. However, there is a large variation across countries in terms of characteristics of labor share fluctuations. India, for instance, having the lowest income per capita in the sample does not show a procyclical labor share.

In contrast, Korea has a strongly procyclical labor share although it is one of the richest emerging economies. Figure-2, on the other hand, provides us with a clearer picture. It shows that labor share is procyclical with output especially in the countries with countercyclical interest rates, i.e., a decrease in the cost of borrowing during booms tends to increase labor share. The more countercyclical interest rates are, the more procyclical labor share is. Moreover, countries that face more volatile interest rates tend to have more volatile labor shares, as well. In addition, section-2 shows that negative slope coefficients in Figure-1 disappear when the fluctuations in the interest rate are taken into account. Finally, these results are shown to be robust to adjustments of the labor share that controls for self-employment and the informal sector.

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Labor Share Fluctuations in Emerging Markets: The Role of the Cost of Borrowing