Why did worker power decline?

We develop a theoretical model in which the income distribution is endogenously determined by firms’ market power in both product and labor markets and the probability of financial crisis is endogenously determined by the accumulation of household credit. Using the model, we analyze the transitional dynamics of an economy undergoing structural changes in product and labor markets.
We find that the secular rise of firms’ market power in both product and labor markets can be an important driver behind a few secular trends experienced by the U.S. economy in the last four decades: the decrease in both the labor share and the capital share, the increase in the profit share, the increase in income inequality, the increase in credit-to-GDP ratio, and the associated rise in financial instability summarized by the probability of a financial crisis event. We also show that redistribution policies that moderate income inequality can be used as strong macroprudential tools in preventing financial crises.

Declining unionization, increasingly demanding and empowered shareholders, decreasing real minimum wages, reduced worker protections, and the increases in outsourcing domestically and abroad have disempowered workers with profound consequences for the labor market and the broader economy.
A decline in worker power would be expected to result in lower unemployment without generating inflation. That is because a decline in workers’ ability to share in profits may increase firms’ incentive to hire, and a decline in the availability of high-wage jobs reduces unemployed workers’ incentive to hold out in the hope of getting one of these jobs. The authors show that the decline in worker power is big enough to explain the decline in the average unemployment rate since the 1980s, and that industries with bigger falls in worker power had bigger falls in their unemployment rates.