Will falling domestic labor compensation share really be improved when global trade slowdown?

Since the 1980s, globalization, driven by information technology and trade liberalization, has facilitated the emergence of Global Value Chains (GVCs). While GVC participation has been linked to increased national wealth and per capita income, its impact on income distribution remains a subject of debate. Some scholars argue that GVCs contribute to a decline in the domestic labor compensation share, as a significant portion of the revenue generated is concentrated among large multinational corporations. This paper investigates this relationship, aiming to understand the causal link between GVC participation and the domestic labor compensation share, considering the changing dynamics of GVC participation since 2010. The study focuses on three key improvements: it utilizes the Solow-Acemoglu-Guerrieri (SDA) method to decompose the domestic labor compensation share, accounting for various factors that influence it; it analyzes the role of overseas labor availability in undermining the Stolper-Samuelson theorem under vertical specialization; and it distinguishes between the impact of forward and backward GVC participation, highlighting the potential benefits of upstream engagement in GVCs. The overarching research question is whether reduced GVC participation resulting from a global trade slowdown can improve the domestic labor compensation share, and if so, under what conditions.

Existing literature on the relationship between GVC participation and domestic labor compensation share is mixed. Studies like Timmer et al. (2014) initiated discussions about this complex interplay, with subsequent research recognizing the negative effects of GVC participation on labor compensation share (Aguiar de Medeiros and Trebat, 2017; Barton, 2017). Several mechanisms have been proposed: firms embedded in GVCs tend to adopt more capital-intensive technologies (Bernard et al., 2018), exacerbating bargaining asymmetries between labor and capital (Becker et al., 2013; Shepherd and Stone, 2013). Studies have shown that GVC gains are often captured by capital owners, worsening income inequality, as exemplified in the Indonesian coffee industry (Vicol et al., 2018). This phenomenon is not limited to developing countries; Hummels et al. (2014) and Borghi and Crinò (2013) found that offshoring impacts high and low skilled workers differently in developed countries, widening the capital-labor income gap. The current paper aims to advance this research by addressing the limitations of existing studies and developing a more nuanced understanding of this relationship.

The study employs a comprehensive methodology to analyze the relationship between GVC participation and domestic labor compensation share. GVC participation is measured using the Koopman-Wang-Wei (KWW) method, which decomposes export value-added into domestic and foreign components. Three indicators are used: GVCParBackward (backward linkages), GVCParForward (forward linkages), and GVCParticipation (the sum of forward and backward linkages). The availability of overseas labor is measured using the GVCs income method (Timmer et al., 2013), which decomposes domestic employment into domestic and foreign contributions. The domestic labor compensation share (Laborshare) is the explained variable. The study utilizes the SDA method of Solow (1958) and Acemoglu and Guerrier (2008) to decompose the Laborshare, identifying four factors: intra-industry income distribution effect, intermediate product substitution effect, multiplier effect of industry linkage, and demand structure upgrading effect. A benchmark regression model is developed (Eq. 13), which includes GVC participation indicators and control variables such as technological sophistication index (TSI), consumption structure (CS), capital accumulation (KL), and high-skilled labor (Highskill). To investigate the mechanisms, moderating effect analysis is employed to test whether capital-biased technological progress (TB) and overseas labor availability (FL) influence the relationship between GVC participation and labor compensation share (Eqs. 19-22). Two-stage least squares estimation is used to address potential endogeneity issues, employing trade flow and 1980 foreign trade dependence as instrumental variables. Data from 51 economies (including OECD and non-OECD countries) from 2000 to 2018, obtained from the OECD Input-Output Database, TiVA database, WIOD, ILOSTAT, and World Bank database, are used for the analysis. Robustness checks are conducted by altering sample intervals and replacing indicators.

The benchmark regression analysis (Table 4) confirms the negative relationship between GVC participation and labor compensation share (H1). For every 1% decrease in GVC participation, labor compensation share increases by 0.11%. However, this effect is primarily driven by backward GVC participation; forward participation does not significantly impact labor compensation share. Robustness tests (Table 5), using sub-sample intervals and alternative indicators (Gini coefficient), confirm these findings. Endogeneity tests (Table 6) using instrumental variables show that the causal relationship is from GVC participation to domestic labor compensation share. Mechanism analysis (Table 7) reveals that capital-biased technological progress (H2a) and the availability of overseas labor (H2b) are key mechanisms through which GVC participation reduces labor compensation share. Heterogeneity analysis (Table 8) shows consistent negative effects of GVC participation across different time periods, levels of economic development, and GVC positions (manufacturing vs. non-manufacturing).

The findings highlight the complex relationship between GVC participation and domestic labor compensation share. The negative relationship, particularly driven by backward GVC participation, suggests that while GVC participation increases overall efficiency and growth, it does not always translate into equitable income distribution. The identification of capital-biased technological progress and overseas labor availability as key mediating factors sheds light on the mechanisms through which GVCs affect income distribution. The positive impact of forward participation suggests a path toward more equitable integration into GVCs, focusing on higher value-added activities. This implies that policies focusing on upgrading to higher value-added activities in GVCs, promoting fair competition and reducing reliance on cheap overseas labor are crucial for addressing the distributional challenges associated with global value chains. The results are relevant to policymakers seeking strategies to balance the efficiency gains of GVC participation with more equitable income distribution.

This study demonstrates a negative relationship between GVC participation and domestic labor compensation share, especially driven by backward participation. Capital-biased technological progress and readily available overseas labor exacerbate this effect. However, forward participation in GVCs presents a more equitable path. The findings underscore the need for policies promoting fair competition, industrial upgrading, and the establishment of relational value chains to improve labor compensation share. Future research should focus on a more in-depth analysis of specific industries and the role of technology spillovers in shaping income distribution within GVCs.

The study acknowledges several limitations. The use of value-added decomposition to measure GVC participation and position may introduce multicollinearity. The study's focus on aggregate data may obscure industry-specific variations. Further theoretical modeling is needed to rigorously demonstrate the relationship between GVC participation and the validity of the Stolper-Samuelson theorem. Finally, a more granular analysis of technology spillovers is needed for a comprehensive understanding of the impact of GVCs on income distribution.