Labor Income Distribution and the Expenditure Elasticity Channel

Danieli, Ana

doi:https://doi.org/10.21985/n2-6fcy-0e72

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Labor Income Distribution and the Expenditure Elasticity Channel

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I analyze a new mechanism through which changes in aggregate income can result in changes in the labor income distribution. This mechanism arises from heterogeneity in the expenditure elasticity of different sectors and in their employment composition. Once total income increases the mechanism suggests that consumption will be re-allocated towards sectors with higher expenditure elasticity increasing their relative demand. This in turn implies that the relative demand for employees that work in producing these high elasticity sectors increases as well. In this research I document that these employees tend to be at both ends of the income distribution which suggests a significant feedback effect on the labor income distribution that I examine both empirically and theoretically. This mechanism is expected to be relevant at both business cycle frequency and over long time periods. I therefore examine it's relevance in three different frameworks. In my first chapter I examine the effect of the mechanism following a monetary policy shock and find it results in a decrease in inequality that is equivalent to redistribution of 45% of company profits. I further find that this effect on inequality decreases overtime. In my second chapter I examine the effect on inequality in the COVID-19 crisis compared to a standard recession. I find that compared to a standard recession the increase in inequality is almost twice as large due to both different employment composition of the sectors that are being affected most and the expenditure elasticity channel. Lastly, in my third chapter I examine the effect of the mechanism on labor market polarization in the US between 1980-2016 and find that it can account for 50% of the increase in the wage bill share of high-skill occupations, 60% of the decline for medium-skill occupations and virtually all of the increase in the wage bill share of low skill occupations.

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