Ideal Labor Share to max Employment… message to the Fed

This post is a message to the Federal Reserve if they are serious about maximizing employment.

Yesterday I posted a model for labor share plotted against labor (Qty.) in response to a post by Simon Wren-Lewis.

The model suggests that there is an ideal level of labor share that will employ the most amount of people. How well does this model hold up to real data? The following graph would suggest an effective labor share of 84% would  allow the economy to reach its maximum level of employment.

This plot contains data from 1950 to 2ndQ-2014. Labor share on the y-axis. Employment rate on the x-axis. (Employment rate is a measure of employing labor as in the x-axis of the model graph above.) The various decades have been color coded.

A pattern emerges that matches the model. The sloping black lines demarcate the boundaries of labor supply and labor demand. In the 1950s and 1960s, the plot moved nicely parallel to the labor demand curve allowing us to see it clearly. Basically, we can see that an optimal level of effective labor share would be 84%. That is where employment is maximized. We hit that level in the 1950s, and then came close in the 1960s and 2000s.

Note: The plot is scattered between the supply and demand curves due to economic contractions where employment fell without an equal change in labor share. As the economy would rebound from a contraction, it would head toward the supply/demand boundaries of the model. You can actually see time periods when the labor supply and labor demand curves shifted to the left. But I won’t go into those shifts here. Only to say that those shifts support an effective labor share between 82% and 84% to max employment.

The model suggests that currently, unemployment will hit the supply limit above a 5.5% rate. (see blue line near bottom.) This unemployment rate is in line with many projections.

As the plot hits the black boundary, labor share and employment tends to rise before a contraction sets in. Employment stalls. I suspect that we will see this effect within a couple quarters time.

But the message to the Federal Reserve is this… a higher labor share will give a lower unemployment rate.