After rising to 10 percent in the wake of the Great Recession, the unemployment rate is now approaching a level that many observers--including the Congressional Budget Office, as shown in Figure 1--associate with the natural rate of unemployment.

Figure 1. The Unemployment Rate

Source. Bureau of Labor Statistics, Congressional Budget Office.

* Long-run estimate

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However, there is uncertainty over whether structural changes in the labor market in recent years have changed the natural rate. In arguing that it has, some observers have pointed to an outward shift in the Beveridge curve (see Figure 2) which suggests that a given level of demand, represented by vacancies, is consistent with a higher level of unemployment now than previously. In fact, in the first quarter of 2015, the rate of job openings (as measured by the BLS's Job Openings and Labor Turnover Survey) was at its highest level since the first half of 2001.

Figure 2. The Beveridge Curve

Note. The JOLTS Job Openings rate is shown as total nonfarm job openings divided by the labor force.

Source. Bureau of Labor Statistics.

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However, the Beveridge curve, by itself, cannot identify shifts in the natural rate, as argued by Diamond and Şahin (2014) and Daly, Hobijn, Şahin, Valletta (2012), among many others. It is also necessary to know the equilibrium level of job openings, or vacancies, firms desire to post relative to the level of unemployment. Indeed, analysis that relies on shifts in the Beveridge curve alone to identify the natural rate implicitly assumes that there has been no concurrent shift in the structural, or persistent, factors determining the job creation incentives of firms.¹

We argue that the recent secular decline in the labor share (shown in Figure 3) has been driven by structural factors that also tend to raise the vacancy-unemployment (V-U) ratio, and that this has, in turn, served to reduce the equilibrium unemployment rate. As shown in Figure 3, the labor share of income has moved noticeably below levels that prevailed until the early 2000s (see Elsby, Hobijn, and Şahin (2013) and Karabarbounis and Nieman (2014) for recent work on the labor share).² Smoothing through some of the volatility in the data, the labor share has declined by roughly 6.5 percentage points since the early 2000s and now hovers around 63 percent. Through the lens of a standard labor market model, we argue that if the decline in the labor share has been driven by a reduction in worker bargaining power, the incentive for firms to post vacancies has increased and equilibrium unemployment will be lower as a result.

Figure 3. The Labor Share

Note. Nonfinancial Corporate Sector. Calculated as compensation divided by gross value added less taxes on production and imports.

Source. Bureau of Economic Analysis.

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In this note, we first sketch the implications of declining worker bargaining power for equilibrium V-U ratios in a standard model of unemployment. Then we exploit industry and state variation in the labor share and V-U ratios to quantify the empirical relationship. We find that the decline in the labor share is associated with increased V-U ratios which, in our model, translates into a reduction in the equilibrium unemployment rate of about two-thirds of a percentage point.

Equilibrium Unemployment in the Canonical Search Model

Below we provide a very brief sketch of the canonical Diamond-Mortensen-Pissarides search model of unemployment. Our presentation is in the spirit of Daly, Hobijn, Şahin, and Valetta (2012), and we refer readers to Chapter 1 of Pissarides (2000) for a more formal treatment. In this type of model, workers search for available jobs and firms search for available workers, but frictions such as geographic or skill mismatch, and potentially other impediments, make matching a lengthy process and generate involuntary unemployment. Once matched, firms and workers determine a wage through a bargaining process, and split the returns from the match.

Equilibrium in such a model can be easily depicted by the intersection of two curves, the Beveridge curve (BC) and the job creation curve (JC), a stylized version of which is shown in Figure 4. Given the technology governing the matching of searching workers and vacant jobs, the BC depicts the unemployment rate for any level of vacancies when flows in and out of unemployment are equalized (so-called steady-state unemployment). It is downward sloping because fewer vacancies, say during a recession, lead to lower job finding and thus higher unemployment. The intercept (or vertical position) of the Beveridge curve is determined in part by the efficiency with which unfilled jobs are matched to unemployed workers. Outward shifts in the Beveridge curve, such as the one depicted in Figure 2, have been ascribed to diminished matching efficiency, such as in Barnichon and Figura (2015).³

The equilibrium V-U rate is determined by firms' desire to post vacancies given an unemployment rate and is depicted by the JC. In equilibrium, firms choose to post vacancies up until the point that the cost of filling a job is equal to the return from a filled position. When there are more unemployed workers, all else equal, filling a vacancy becomes cheaper, and desired vacancy posting rises, resulting in the upward-sloping shape of JC. The JC can also shift over time. From the trough to the peak of the business cycle, rising growth in aggregate demand and productivity cause desired vacancies to rise and the JC to rotate counterclockwise. Other factors can also influence the position of the JC. Daly et al. (2012), for instance, highlight changes in unemployment insurance and economic uncertainty as structural factors influencing the slope of the JC.

Figure 4. Equilibrium of the Diamond-Mortensen-Pissarides Search Model

What has been largely ignored are the implications of the considerable secular decline in the labor share over the last decade for equilibrium unemployment and vacancies. These implications, of course, depend on the factor causing the decline. Certain factors, such as a decrease in worker bargaining power, would cause a lower labor share to be associated with higher firm profits and, as firms cash in on the higher returns from job creation, a higher V-U ratio. This would cause the JC to rotate counterclockwise and the equilibrium to move from point A to point B, further up the Beveridge curve, in Figure 4. Other factors, such an increased risk of job destruction or a higher discount rate applied to future profits, would cause a lower labor share to be associated with a reduced V-U ratio.⁴ In this case, the JC would rotate clockwise to point C.⁵ Our simple analysis of the canonical search model therefore suggests an empirical examination of the secular comovement in the labor share and the V-U ratio.

Empirical relationship between labor share and V-U ratio

We exploit variation across industries and states to identify the empirical relationship between the labor share and the V-U ratio.⁶ We first combine annual data from the NIPA accounts (from the Bureau of Economic Analysis) on the labor share together with JOLTS and CPS data (from the Bureau of Labor Statistics) on vacancies and unemployment for thirteen private-sector industries that cover the period from 2001 through 2014.⁷ We then estimate the relationship between the labor share and the V-U ratio in two ways. First, we simply estimate the cross-sectional relationship between the change in an industry's labor share (in percentage points) from 2001 to 2014 and the change in the industry's log V-U ratio over the same period. This estimate is given in column 1 of Table 1 and depicted in Figure 5. In column 2 of the table, we present estimates from a panel regression that includes industry and year fixed effects.

Figure 5. Changes in Industry-level Labor Share versus Changes in V-U Ratios, 2001-2014

Source. Bureau of Labor Statistics and Bureau of Economic Analysis.

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