International Diversification, Reallocation, and the Labor Share
Abstract: How does growing international financial diversification affect firm-level and aggregate labor shares? We study this question using a novel framework of firm labor choice in the face of aggregate risk. The theory implies a cross-section of labor risk premia and labor shares that appear as markups in firm-level data. International risk sharing leads to a reallocation of labor towards riskier/low labor share firms alongside a rise in within-firm labor shares, matching key micro-level facts. We use cross-country firm-level data to document a number of empirical patterns consistent with the theory, namely: (i) riskier firms have lower labor shares and (ii) international financial diversification is associated with a reallocation towards risky/low labor share firms. Our estimates suggest the reallocation effect has dominated the within effect in recent decades; on net, increased financial integration has reduced the corporate labor share in the U.S. by about 2.5 percentage points, roughly one-third of the total decline since the 1970s.
Keywords: international diversification; international risk sharing; reallocation; labor share;
JEL Classification: E24; E25; E44; F21; F4; F62; F66; G15;
Provider: Federal Reserve Bank of Chicago
Part of Series: Working Paper Series
Publication Date: 2023-04-20
Number: WP 2023-16