Labor Share and development

We highlight a U-shaped relationship between development and the labor share of in- come. We exploit the within dimension of a panel dataset for the wage bill and value added in the manufacturing sector for developing countries. Data is available at the aggregate man- ufacturing level and also at the disaggregate level for 28 manufacturing subsectors. We show that the U-shaped pattern of the labor share that we observe at the aggregate level is also observed at the subsector level suggesting it does not correspond to reallocation forces across sectors that occur during the development process. Our theory emphasizes the role of firms’ monopsony power when labor market has frictions in a dual labor market in which modern, high productivity firms coexist with traditional, low productivity firms. At earlier stages of development, productivity gains are not compensated by wage increases, as most of workers’ outside opportunities depend on the low productivity traditional sector. At later stages, the labor share increases as a result of wage competition in the modern sector.