Firm Heterogeneity and the Aggregate Labour Share

Using a static model of firm behaviour with imperfect competition on the product and labour markets, we quantify the effect of firm heterogeneity in total factor productivity, market power, capital, wages and prices on the aggregate labour share. In particular, we suggest a new decomposition of the aggregate labour share in terms of the first moments of the joint distribution of these variables across firms, providing a bridge between the micro and the macro approach to functional distribution. We provide an application of our method to the UK manufacturing sector, using firm-level data for the period 1998-2014. The analysis confirms that heterogeneity matters: in an economy populated only by representative firms, the labour share would be 10 percentage points lower. Among all the dimensions studied, heterogeneity in total factor productivity and labour market power are the most relevant ones, whereas heterogeneity in product market power matters the least, with wages and prices in between. However, the observed fall in the aggregate labour share over the period is mostly explained by a widening of the disconnect between average productivity and real wages, with a smaller role for an increase in the average product and labour market power of firms after the Great Recession, while changes in the dispersion of these variables mostly offset each other.