Accounting for Factorless Income

Comparing U.S. GDP to the sum of measured payments to labor and imputed rental payments to capital results in a large and volatile residual or “factorless income.” We analyze three common strategies of allocating and interpreting factorless income, specifically that it arises from economic profits (Case Π), unmeasured capital (Case K), or deviations of the rental rate of capital from standard measures based on bond returns (Case R). We are skeptical of Case Π as it reveals a tight negative relationship between real interest rates and economic profits, leads to large fluctuations in inferred factor-augmenting technologies, and results in profits that have risen since the early 1980s but that remain lower today than in the 1960s and 1970s. Case K shows how unmeasured capital plausibly accounts for all factorless income in recent decades, but its value in the 1960s would have to be more than half of the capital stock, which we find less plausible. We view Case R as most promising as it leads to more stable factor shares and technology growth than the other cases, though we acknowledge that it requires an explanation for the pattern of deviations from common measures of the rental rate. Using a model with multiple sectors and types of capital, we show that our assessment of the drivers of changes in output, factor shares, and functional inequality depends critically on the interpretation of factorless income.