China Economic Review xxx (xxxx) xxx–xxx

Contents lists available at ScienceDirect

China Economic Review

journal homepage: www.elsevier.com/locate/chieco

“Made in China” matters: Integration of the global labor market

and the global labor share decline☆
⁎
Xiang Xua, David Daokui Lib, Mofei Zhaoc,
a
School of Economics, Central University of Finance and Economics (CUFE), and Hoover Institution, Stanford University, United States
b
CCWE, Tsinghua University, Beijing, China
c
International School of Economics and Management, Capital University of Economics and Business, China

A R T IC LE I N F O ABS TRA CT

Keywords: We show that the integration of Chinese labor into the global labor market has played a key role
Global labor share in the global labor share decline since the late 1970s. Several key institutional changes, including
Labor migration the “reform and opening-up” that began in the late 1970s and China's entry into the WTO in
Dual economy 2001, accelerated this process. We build a two-country dual economic model to explain how
JEL classification: labor shares decline in labor-intensive and capital-intensive countries simultaneously. Our em-
E21 pirical results show that the integration of Chinese labor significantly affects the global labor
E22 share, mainly through the channel of international trade and especially processing trade business.
E25

1. Introduction

The global labor share has declined significantly since the early 1980s, with the decline occurring within a large majority of
countries and industries. Karabarbounis and Neiman (2013) document a 5% decline in the global corporate labor share from 1975 to
2012. The headline measure published by the Bureau of Labor Statistics in the U.S. also indicated a downward trend, from ap-
proximately 64% in the mid-1980s to approximately 58% in recent years. We find that, aside from some plausible stories in the
literature, the labor share decline can be explained largely by global labor market integration, especially the integration of immigrant
workers (i.e., workers moving from rural to urban areas) in China.
In the past 40 years, institutional changes and reforms have broken down internal and external labor market barriers in less-
developed countries. The size of the global labor supply doubled, as China, India, and ex-Soviet bloc nations joined the global
economy through international trade (Freeman, 2006). Notably, China is the biggest contributor to “the great doubling”of the global
labor force.
We investigate the integration of China's labor market from 1978 and 2013, which was triggered mainly by the labor market
reform that reduced the urban-rural barrier. Rural migrants have become the most important source of new urban labor, and the
migration process was accelerated by institutional changes such as the hukou reform and China's entry into the WTO in 2001. In
general, migrant workers (from rural areas) require lower wage; and they have made up the majority of labor in China's export sector
(especially the processing trade sector). Through international trade, China's cheap labor force joins global competition and affects
global labor income levels and the share of labor in total outputs.
In this paper, we propose a framework to model the global labor integration process. We show that this framework can be used to

☆
We are grateful to Niall Ferguson, Richard Freeman, Yangbo Song, Puyang Sun, Guang Yang, and the seminar audience at Hoover Institution and Tsinghua
University for helpful suggestions.
⁎
Corresponding author.
E-mail address: mofeizhao@ucla.edu (M. Zhao).

https://doi.org/10.1016/j.chieco.2018.05.008
Received 5 December 2016; Received in revised form 16 April 2018; Accepted 14 May 2018
1043-951X/ © 2018 Published by Elsevier Inc.

Please cite this article as: Xu, X., China Economic Review (2018), https://doi.org/10.1016/j.chieco.2018.05.008
X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

analyze the dynamics of the global labor market and of individual countries; we show that global labor integration is particularly
explanatory for the decline of labor shares both at the global level and within individual economies and industries.
Specifically, we develop a two-country dual economic model that relates labor share declines to the surplus labor reserve in the
agricultural sector in China. In the model, capital (or, equivalently, capital-intensive intermediate products) flows into labor-in-
tensive countries when rural labor migrates from the agricultural sector to the processing industry sector. Wages grow more slowly
than output because migrant workers lack bargaining power and require lower wages than their marginal productivity. In capital-
intensive countries, lower domestic labor demand and the growth in capital-intensive industries increase the capital share. In both
countries, the labor share declines.
Using panel data on industry outputs, imports, and exports from the major countries, we identify a strong relationship between
the China's labor integration and labor income share. According to our estimation, about 60% of the global labor share decline from
1995 to 2011 can be explained by China's growing international trade, labor migration, and labor market globalization. We also
identify the relative price of investment, the share of capital formation in total output and structural changes as key explanatory
variables for the global labor share changes. Next, we conduct a sector-level regression on each sector’ import exposure to China, as
well as its export of intermediate good to China. We find that the import exposure’ effect on labor share is similar to that of the overall
trade. We also find that export of intermediate good is particularly explanatory for the sectoral labor share decline.
Our contribution to the existing literature on the labor share is twofold. First, we build a simple yet useful framework to study the
labor share decline in both labor-intensive and capital-intensive countries. This framework is the first to highlight the influence of
developing countries' labor market structure in determining the global labor share. Our framework can be expanded to consider labor
market frictions, different types of technology improvements, terms of trade and price markups in the determination of the global
labor share.
Our second contribution is our quantitative analysis on the influence of global labor share determinants, especially trade with
China. We apply panel regression to identify key explanatory factors of the global labor share decline and test the effect of key
institutional changes. Our empirical analysis indicates the importance of the globalization of developing countries in labor income
share dynamics, which has been either controversial or overlooked in the existing literature.
Notably, in the literature, there are papers that propose trade and globalization as potential explanations for the decline in the
U.S. labor share, but mainly as side evidence, and their results are controversial. The following two papers hold particularly different
opinions.
Karabarbounis and Neiman (2013) claim that trade and globalization are unlikely to explain the labor share decline for two
reasons. First, China's labor share also decreased during that period, which should not have occurred if we consider China to be a
relatively labor-abundant economy that has opened up to trade and that absorbs the labor-intensive departments of the U.S. Second,
trade induces compositional change in industries rather than changes within industry; however, their research shows that labor share
trends are explained largely by within-industry changes rather than the between-industry changes.
On the other hand, Elsby, Hobijn, and Sahin (2013) are in favor of the trade explanation. They use a set of simple cross-industry
regressions and their empirical results suggest that increases in the import exposure of U.S. businesses can explain approximately 3.3
percentage points of the 3.9 percentage point decline in the U.S. payroll share in the past quarter century.
Notably, the focuses of these papers are elsewhere (such as other explanations for the decline in the labor share), and neither of
them conducted a more detailed analysis from the trade perspective. In this regard, our empirical study confirms and develops Elsby
et al. (2013)’s findings.
Despite the debate in the literature, we propose an alternative explanation. First, the two-country dual economy model we
proposed has surplus labor in the agricultural sector of China, where the labor share is much higher than that of the corporate sector
of China. As a result, if a more labor-intensive segment of U.S. production is offshored to China, China's labor share may decline
simultaneously, since it transfers its surplus labor in the (high labor share) agricultural sector to the (low labor share) new industries.
Second, trade does not (necessarily) trigger only compositional (between industry) changes. Nowadays, global industry in-
tegration often takes the form of vertical specialization. That is, countries specialize in particular stages of a good's production
sequence, rather than in the production of the entire good, as discussed by Hummels, Ishii and Yi (2001) and Yi (2003). Notably, the
specialization (segmentation) may take place within the same industry rather than between different industries. Thus, if a more labor-
intensive segment of a particular industry in the U.S. has been shifted to countries with relatively low labor costs, the labor share of
the remaining production within this industry would decrease much more quickly than the scale of the industry itself, while the
overall economy would still be expected to become more capital intensive. This argument conforms to Karabarbounis and Neiman's
findings that within-industry changes account for most of the labor share decrease and resolve the counterfactual results they argued
against.
The remainder of this paper is organized as follows. Section 1.1 reviews the literature. Section 2 introduces the historical context
of how China has integrated into the global labor market and how it may have affected the global production factors. Section 3
presents a two-country dual economy model to explain the labor share decline in both labor-intensive and capital-intensive countries.
Section 4 presents our regression results on both a cross-country panel and a cross-sector panel; and it provides empirical evidence for
our theoretical model. Section 5 concludes and discusses the policy implications of our research.

1.1. Literature review

Our paper is related to three strands of the literature. The first investigates the trends in the labor share and tries to explain its
apparent decline in recent years. The second investigates mainly global labor market integration, especially the role China plays. The

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third is the classical dual economy model and associated empirical studies.

1.1.1. Literature on the global labor share decline

Our paper follows the steps of extensive literature focusing on documenting and explaining the global labor share decline since
the late 1970s. Ever since Kaldor (1957), the stability of factor shares has been used broadly in macroeconomic models, including
Cobb-Douglas production models and growth models. The stability of labor shares of OECD countries has been challenged since the
late 1990s, when Blanchard, Nordhaus, and Phelps (1997) discovered the properties of the medium run, a period of transition from
short-term fluctuation to long-term growth and documented declining labor shares of continental Europe countries since the early
1980s. Angrist and Krueger (1999), Acemoglu and Ventura (2002), Blanchard and Giavazzi (2003), Jones (2003), and Bentolila and
Saint-Paul (2003) focus on the labor shares of OECD countries and also discover large declines since the 1970s. Karabarbounis and
Neiman (2013) document a 5% decline in the global corporate labor share from 1975 to 2012 based on country-specific data that
include labor share data for > 110 countries. They use the corporate labor share to circumvent measurement difficulties for the
overall labor share. They find that 42 of the 59 countries with at least 15 years of records exhibited downward trends in their labor
shares. Harrison (2005) and Rodriguez and Jayadev (2010) extend these results to non-OECD countries and find that labor share
declines also exist in developing countries. Portes and Hoffman (2003) document that labor shares in Latin American countries kept
decreasing from the 1950s to the 1990s. Regarding China's scenario, Bai and Qian (2009a, 2009b) and Li, Liu, and Wang (2009)
discover a significant labor share decline in China since the early 1990s.
A few recent papers address the question of why the labor share has declined globally. Four kinds of factors have led to global
labor share decline in the last 35 years.
The first is the decline in the relative price of investment. Karabarbounis and Neiman (2013) find that > 90% of the labor share
decline reflects within- industry declines rather than between-industry declines (see also Gollin (2002)). They attribute the decline in
the labor share to the decline in the relative price of investment goods, which, according to their estimation, explains roughly half of
the global labor share decline. In a similar spirit, Piketty and Zucman (2014) attribute global labor share decline to the long-run
recovery of asset prices and the slowdown of productivity and population growth. Bridgman (2017) nets out capital depreciation and
production taxes in the gross labor share and finds that net labor share does not decline as much as the gross labor share in the U.S.
and other large countries.
The second factor is structural changes of economies. Blanchard and Giavazzi (2003) systematically study how regulation and
deregulation in goods and the labor market affect wages, unemployment, and the labor share. According to their research, the
significant decline of the labor share of Western Europe in the 1980s was due mainly to a decrease in the bargaining power of workers
and heightened labor market deregulation. Li, Liu and Wang (2009) build a dual-economy model to illustrate labor share movements
in the industrialization process of developing countries. Their empirical results support the view that the labor share in economic
development seems to follow a U-shaped curve, the lowest point of which is USD 6000 per capita PPP (2000 constant).
The third factor is technology. In Hicks' (1932) theory, the labor share of output, or the labor share divided by the capital share, is
determined by three factors: the capital-labor ratio, factor-augmenting technology and the elasticity of substitution. A majority of
existing estimates indicate a short-run elasticity of substitution that is less than one (Chirinko, Fazzari and Meyer, 1999, Krusell,
Ohanian, Rios-Rull, and Violante, 2000, Antras, 2004, Klump, McAdam and Willman, 2007, Oberfield and Raval, 2014). Some recent
studies suggest that the long run elasticity of substitution could be higher than one (Acemoglu and Ventura, 2002, Karabarbounis and
Neiman, 2013); if this is proven correct, developments in capital-augmenting technology will significantly influence the global share.
The fourth factor is the integration of the global labor market, and this is the factor we emphasize in this paper. Elsby et al. (2013)
mention the possibility that the expansion of the global labor force may directly reduce the capital-labor ratio and the labor share, but
only as side evidence. Dorn, Katz, Patterson, and Van Reenen (2017) also discuss the influence of trade on the decline in the labor
share. However, their argument mostly deals with the industry organization aspect, and shows that trade gives rise to “superstar
firms”, which in turn depresses the labor share. From a different approach, we document the influence of China on the global labor
market in the last 35 years and demonstratethat labor market integration can largely explain recent labor share movements, espe-
cially the global labor share decline. Finally, our empirical approach is analogous to Bockerman and Maliranta (2011), even though
their research focus is the relationship between increased international trade and labor share changes at micro level.

1.1.2. Literature on the global labor market

Although the question of whether global trade integration has resulted in the global labor share decline is controversial, trade's
influence on other labor market outcomes has been intensively discussed for a long time (see Borjas, Freeman, Katz, DiNardo, and
Abowd (1997)). Our paper focuses particularly on the impact of the international trade associated with China. We choose this
approach for two reasons. First, China contributes the most to global labor market integration. Second, compared with those from
other countries, exports from China have had the most profound influence on the global labor market over the last 30 years. Our
finding on the impact of global labor integration is related to the work by Freeman (2006). His documentation of global labor market
integration shows how labor from China, India, and the ex-Soviet bloc nearly doubles the global labor force in the last two decades of
the 20th century and completely changes the supply-demand relationship in the global labor market.Ferguson and Schularick (2007
and 2009) focus on the bilateral trade relationship between China and the U.S. and find that this two-sided economic phenomenon
can provide the best explanation for increasing global returns on capital and the low cost of capital as measured by the long-term real
interest rates before the 2007 global financial crisis. Whitfield (2016) studies the domestic impact of China's integration in the global
labor market and finds that China is actually racing to the bottom of global labor standards.
Our finding that trade with China significantly affects foreign labor market conditions complements the work by David, Dorn and

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Hanson (2013) and Autor, Dorn and Hanson (2016), who both focus on how rising Chinese import competition affected the U.S. local
labor market. They find that rising import exposure in the U.S. has caused higher unemployment, lower labor force participation, and
reduced wages in local labor markets that further result in the declining labor share. Our finding that trade with China is a main
contributor to global labor income share decline can be seen as an extension of Elsby et al. (2013), who prove that trade and
manufacturing are two key determinants of the labor share decline in the U.S. since the mid-1980s, while offshoring of labor-
intensive components of the U.S. supply chain is the most plausible explanation for the decline in the U.S. labor share since the 1980s.
They also find empirical evidencethat contradict explanations from the perspective of capital-labor substitutability and de-union-
ization. The implications of our work on inequality are also related to their findings.

1.1.3. Literature on the economic development of dual economies

Because China is a relatively labor-abundant economy, according to the Heckscher-Ohlin and Stolper-Samuelson theories, in-
ternational trade integration should increase China's labor share. However, we observe a labor share decline in most of China's
production sectors. The corporate labor share in China decreased from 44.6% in 1992 to 36.6% in 2009, and the overall labor share in
China decreased from 59.3% in 1992 to 49% in 2009. While we adhere to the HeO and SeS theories, we must adjust our assumptions
to fit the scenario. The key factor is China's massive labor immigration. China had the largest rural surplus labor in the world when
the Chinese government announced the reform and opening-up policy in 1978. In the following 35 years, this reserve of surplus labor
has fueled China's economic growth by keeping wage rates relatively low, which in turn decreases the labor share. This observation is
in line with the dual economy theory of economic development.
The dual economy features of our two-country model are related to the seminal contributions of Lewis (1954). He established the
basic dual-economy model to analyze the transition from the traditional agricultural sector of an economy to its modern industrial
sector. In the Lewis model, the traditional (agricultural) sector has surplus labor with zero marginal productivity, and the transition of
labor from the traditional to the modern sectors of an economy marks economy development. Through capital accumulation, the
modern sector absorbs labor from the traditional sector until surplus labor is exhausted and the marginal productivity of both sectors
converges. Ranis and Fei (1961) emphasize the importance of surplus production from agriculture and improve the modeling of the
labor transfer process. Jorgenson (1967) builds a neoclassical model to study the relationship between the dual economic structure
and economic development, and he argues that agricultural surplus is the key determinant of economic growth. Harris and Todaro
(1970) focus on migration from rural areas to cities and conclude that the gap between municipal and rural labor income determines
the scale of migration. They also show that in some undeveloped countries where marginal productivity in agriculture is positive and
the unemployment rate in cities is at a fair level, migration from rural areas still occurs and keeps accelerating.

2. Historical context

The massive labor migration from rural areas to urban areas is a major driving force of China's rapid economic growth in the last
35 years (Li, Liu, and Wang, 2009). When the reform and opening-up policies were first implemented in 1978, China had an urban
labor force of 95 million, according to survey data by China's National Bureau of Statistics (NBS). In 2013, this number rose to 380
million. > 150 million people in the new urban labor force, or 52.6%, are immigrants from rural areas. In contrast, from 1978 to
2013, the European and American labor force increased by 26 million and 36 million, respectively.
The integration of Chinese labor into the global labor market through reform and opening-up has a strong impact on the in-
ternational organization of production. In this section, we document China's labor market growth and labor migration from 1978 to
2013 and study how institutional changes have accelerated the labor migration process. Then, we show how China's labor migration
has affected the foreign labor market through processing trade.

2.1. Key institutional changes in China's labor market

China is not the only country with a large amount of rural surplus labor. Indonesia and Pakistan, countries with the 4th and 6th
biggest populations, respectively, both have considerable surplus labor reserves (Foster, McChesney and Jonna, 2011). In the last
50 years, these two countries have not encountered massive labor migration, and their growth rates have not surged. The key
difference between these countries and China is the institutional change in the labor market, specifically, China's hukou reform,
which began in 1978.
The household registration system (hukou) was established in 1958 to collect population information and distribute social re-
sources. Between 1958 and 1978, the Chinese government used the hukou system to control labor migration by forbidding rural
hukou owners to work in urban entities. In that period, the hukou system, along with other methods for the central planning of
economic activities, built strict rural-urban barriers and made it almost impossible for rural workers to leave their farmland.
The reform of the hukou system since 1978 has generated steady labor migration from rural to urban areas. In 1978, China began
its economic reform and opening-up to boost economic growth, and demand in the urban industrial sector rose soon after. In 1985,
China's Ministry of Public Security announced that, with the necessary certificates, rural residents could remain in urban areas. After
the central government's move, local governments also began to gradually lift therural-urban barriers according to their own po-
pulation conditions. Rural labor began to join the industrial production in urban areas. Li et al. (2009) show that due to the huge
surplus labor supply, migrant workers are willing to receive wages lower than their marginal productivity since these reduced wages
are higher than their rural income. This situation allows urban enterprises to enjoy low labor costs. In turn, comparative advantages
in the cost of labor are reflected in low prices and make China's products more competitive in the global market.

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160 20
140
15
120
10
100
80 5
60
0
40
-5
20
0 -10

Net labor migration, right Migrant labor force, left

Fig. 1. China's labor migration (in millions), 1978–2015.

Source: NBS and our estimation.

2.2. Estimating China's labor migration

In this section, we calculate the size of China's labor migration using two methods. First, we calculate the size of the aggregate
immigrant labor force using China's official labor statistics from yearbooks. Second, we decompose the gross labor migration into two
categories and combine the data to calculate gross labor migration annually.

2.2.1. Aggregate immigrant labor force

Our first approach is to calculate the size of China's aggregate immigrant labor force using yearbook data published by the NBS.
The data consist of three entries: the aggregate labor force; rural and urban labor forces; and labor forces of the agricultural,
industrial and service sectors. The aggregate immigrant labor is defined as the difference between rural labor and agricultural labor,
which is equal to the difference between urban labor and non-agricultural labor. Fig. 1 plots aggregate immigrant labor and its year-
on-year differences from 1980 to 2013. We segment the labor migration process into three periods according to the different trends.
The first period is from 1980 to 1996, when surplus labor migrated from rural to urban areas at a high speed. The aggregate
immigrant labor force grew by 11% on a y-o-y basis, while the yearly growth rate of GDP and exports were 10.2% and 13.5%,
respectively. Yearly growth rates of agricultural, industrial and service sectors in that period were 5.1%, 12.3% and 11.5%, re-
spectively, marking the first time non-agricultural sectors grew more quickly than the agricultural sector. The growth momentum in
those two sectors came from the amount of excess labor created by rural-to-urban migration.
The second period was from 1997 to 2002, when China's economic growth rate fell and migrant workers retreated from cities.
There are two reasons for this retreat. First, the Asian financial crisis began in the late 1997, reducing foreign demand for Chinese
exports. Second, the Chinese government began to bankrupt state-owned enterprises (SOEs) in 1997 and laid off millions of urban
workers to increase SOEs' efficiency. This new labor force created by SOE reform competes intensively with immigrant workers and
depressed wage growth, which was much lower than GDP growth.
The third period was from 2003 to the present, and in this period, aggregate immigrant labor returned to positive growth. Since
China joined the WTO in 2001, international trade has grown at top speed and has created a massive number of manufacturing jobs.
From 2003 to 2013, China's total trade volume grew by 18.9% on a year-on-year basis, making great contributions to the country's
economic growth (10.2% per year).

2.2.2. Gross labor migration

Our second approach takes a different perspective. Gross labor migration from rural to urban areas can be divided into two
groups. The first group includes off-farm workers who moved to urban areas to work while leaving their families in rural areas. The
second group includes laborers from migrant households whose entire families migrated to urban areas and stayed there. The data for
the first group can be attained from NBS; those for the second group, however, can be estimated using migration data and dependence
ratios. Table 1 displays the sizes of the two migrant groups and their sum, which is the total labor migration.
We draw the time series of gross labor migration for only 11 years (2001 to 2011) due to data availability. In that period, > 10
million off-farm workers immigrated to urban areas every year; this number began to fall in 2007, at the start of the global financial
crisis, and recovered in 2010. Migrant labor followed a similar pattern. Gross labor migration increased to 19 million in 2010, the
highest number in our time series and in the history of China. A reasonableexplanation for the recovery in gross labor migration is
that the job losses during the financial crisis were filled by new jobs created by China's real estate boom that began in 2010.

2.3. Labor migration, trade, and the global labor market

China's labor migration is not transient or “once and for all”; instead, it has occurred gradually and has lasted for decades until

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Table 1
Total labor migration and its components, in million, 2001–2011.
Source: NBS and our estimation.
Year Total labor migration New migrant workers Migrant households

2001 15.14 N.A. N.A.

2002 13.49 N.A. N.A.
2003 10.00 N.A. N.A.
2004 12.88 5.58 7.30
2005 13.79 8.14 5.65
2006 15.04 8.14 6.90
2007 16.23 5.46 10.78
2008 12.06 5.47 6.60
2009 14.29 4.36 9.93
2010 19.16 12.45 6.71
2011 15.89 10.55 5.34

today. As long as China's rural-urban barriers still exist, we expect labor migration to continue at a slower speed and to exert long-
term influences on the global labor market through export trade. Shi, Wang and Meng (2009) show that as Chinese exporters face
significant increases in labor costs, China's processing trade and related industries have begun to move from coastal areas to Midwest
China, where a large surplus labor reserve still exists.
The other Asian economies have also experienced migration during the takeoff stages of their economic growth. Japan began to
industrialize in 1868, during the Meiji Restoration. However, rural-to-urban migration occurred only after WWI, when Japan began
to rebuild its economy from the war. The largest record of Japan's yearly labor migration occurred in 1967, when approximately 0.25
million rural labors shifted to urban areas. The case of South Korea, another example of the east Asia miracle, was quite different.
Chang and Kim (2006) document that the agricultural share of the labor force of South Korea decreased from 63% in 1963 to 5% in
2005. In the mid-1960s, export-oriented industrial enterprises in South Korea began to expand, and at the same time, labor migration
began to accelerate. The peak of South Korea's labor migration was 0.8 million in 1975, after which the number began to fall. From
1960 to 1980, 6 million rural workers migrated to urban areas. This number was larger than those of all other “tiger economies” but
was not comparable to China's labor migration of 120 million from 1980 to 2000, and its impact on the global labor market was much
smaller.
According to the classic Heckscher–Ohlin model of trade, comparative advantages drive a country to export products that use
factors that are abundant (and cheap). In the case of China, an abundant and cheap rural surplus labor force makes China an exporter
of labor-intensive products. As a result, a classic HeO model would predict an increase in China's labor share and a decrease in
China's trade partners'labor share. However, the labor income share in China also declined in the investigated periods. Karabarbounis
and Neiman (2013) believe that this situation is one of the reasons why China's increasing exports cannot explain the global labor
income share movements. In section IV, we construct a modified HeO model with dual-economy features. This adjustment allows us
to explain why China's labor share also declined in the last 40 years and how China's labor migration affects the global labor share.

3. Theoretical model

In this section, we develop a theory of labor share determination consistent with the statistical facts documented in the previous
section. The two-stage model economy consists of two countries, both of which have dual-economy features but only one is un-
dergoing an economic transition, which, in our model, indicates labor migration.

3.1. Baseline model

Our baseline model is a two-country world in which each economy is specialized in producing a single good, which is consumed
domestically or sold to foreigners. Capital owners install capital for capital income, while labor is internationally immobile.
In the baseline model, we assume that each country has only one production sector: the industrial sector. Workers work for wages
and consume their wages for a living. We assume that the two countries have a C-D production function, which can be easily relaxed
to a CES production function. Entrepreneurs in each country adopt technology Ai, capital Ki, and laborNifor production; αi and 1 − αi
are the output elasticity of labor and capital, respectively. The production function of country i is
Yi = Ai K iαi Ni1 − αi , i = 1, 2 (1)
The theory of investment used in this model relies on the two-country model developed by Lipton and Sachs (1982). Through
equity transactions between capital owners, the global pool of capital is channeled to profitable investment projects, regardless of the
national origin of the savings. Home biases are not considered in the baseline model but can be incorporated easily. In equilibrium,
the capital is transferred between the two countries such that the two countries' marginal returns of capital are equal.
MPK1 = A1 α1 K1α1− 1 N11 − α1 = A2 α2 K2α2− 1 N21 − α2 = MPK2 (2)
or equivalently

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α1− 1 α1− 1
K K
A1 α1 ⎛ 1 ⎞
⎜ ⎟ = A2 α2 ⎛ 1 ⎞⎜ ⎟

⎝ N1 ⎠ ⎝ N1 ⎠ (3)
Eq. (3) shows that in equilibrium, the country with surplus labor (i.e., higher MPK) attracts capital from abroad. As a result, its
domestic return to capital decreases until the returns to capital of both countries are equal.
In this simplified framework, labor is always paid at its marginal production. Thus, if country 1 shifts its capital to country 2 for
production, the labor share of country 1 decreases and that of country 2 increases. However, as Karabarbounis and Neiman (2013)
show, the labor share has declined both in U.S. and in China during the last thirty years. Our baseline model is insufficient to explain
this simultaneous decline. Nevertheless, this model does show that a difference in the marginal productivity of capital can induce a
global capital transfer. In the dual-economy model, we will show that this transfer, if combined with sectoral shifts, will drive down
the labor share in both countries and the global labor share.

3.2. Dual-economy model

We now introduce dual-economy features to the model by assuming an agricultural (or traditional) sector to each country. We use
Bi, Li, and μi to denote, respectively, the total factor productivity, the labor input, and the output elasticity of labor of the agricultural
sector of country i. The agricultural sector of each country differs from its industrial sector in three ways. First, the only two inputs in
the agricultural sector are land and labor, and the land supply is assumed tobe constant (equal to 1). Second, if the labor input of the
agricultural sector (Li) exceeds a certain cutoffLi∗, the marginal productivity of labor of that sector drops to zero. The excess labor
Li − Li∗ in the agricultural sector then becomes surplus labor with zero marginal productivity. Third, Li∗ is determined by technology,
population and land capacity, and these variables are exogenous. The production function of the traditional sector is
Xi = Bi [min (Li∗ , Li ) ]1 − μi , i = 1, 2 (4)
The corporate sector is the same as that in the baseline model.
We assume that the two countries are heterogeneous in their agricultural sector. Country 1 is a less-developed agrarian country
and has existing surplus labor in its agricultural sector, which could be transferred to the modern sector in the long run. Country 2, on
the other hand, is industrialized and more developed in the sense that there is no surplus labor in its agricultural sector.
In the first stage of our model, we assume that all factor income shares are equal to their marginal productivity. We also assume
that due to existing sectoral barriers, labor cannot transfer or migrate between sectors. Thus, the surplus labor in country 1 has no
income because its marginal productivity is zero. Under such circumstances, the labor share of country 1 is
∂X1 (L1∗ ) ∂Y1 (N1 )
∂L1
+ ∂N1
S1l =
X1 + Y1

(1 − μ1 ) B1 (L1∗)−μ1 L1∗ + (1 − α1 ) A1 K1α1 N1−α1 N1

=
B1 (L1∗ )1 − μ1 + A1 K1α1 N11 − α1

(1 − μ1 ) B1 (L1∗ )1 − μ1 + (1 − α1 ) A1 K1α1 N11 − α1

=
B1 (L1∗ )1 − μ1 + A1 K1α1 N11 − α1

(1 − μ1 ) X1 + (1 − α1 ) Y1
=
X1 + Y1 (5)
similarly, for country 2,
(1 − μ 2 ) B2 (L2∗ )1 − μ2 + (1 − α2 ) A2 K2α2 N21 − α2
S2l =
B2 (L2∗ )1 − μ2 + A2 K2α2 N21 − α2

(1 − μ 2 ) X2 + (1 − α2 ) Y2
=
X2 + Y2 (6)
According to (5) and (6), country 1’s and country 2’s labor shares are determined by each country's sectoral output and sectoral
labor income share. Specifically, country i's labor share is a weighted average of its output elasticities of labor, 1 − μi and 1 − αi.
According to empirical studies (Wang, Cai, and Zhang, 2008), a country's agricultural sector has a higher labor share than its
industrial sector (αi > μi for i = 1, 2). Simplified as they are, these equations show us that economic structural changes in the form of
sectoral reallocations of labor could induce significant labor share movements.
In the second stage of our model, we assume that a key institutional change, such as China's reform and opening-up, takes place.
The surplus labor in the agricultural sector of country 1 is now allowed to migrate to the industrial sector. Because the sectoral
barriers are not lifted all at once, only part of country 1’s surplus labor migrates to the industrial sector. This labor migration increases
country 1’s capital marginal productivity and attracts capital inflows from domestic and foreign capital owners.
Instead of assuming that capital flows to country 1 directly, as the baseline model does, we assume here that firms in country 2
can segment the production process into two areas: (1) an intermediate department that consumes only capital and produces an
intermediate product, and (2) a (final) processing department that consumes the intermediate product and labor to produce the final

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X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

product. As the labor in country 2 is relatively expensive compared to that in country 1, a fraction of firms in country 2 shift their
processing department to country 1, leading to the emergence of a new sector in country 1: the processing trade. In this sector,
country 1’s labor is combined with the intermediate good to produce new products. Intuitively, advanced countries export capital-
intensive intermediate products to labor-intensive developing countries such as China, where immigrant labor assembles and
packages those products. For consistency, we use the term “industrial sector” to denote the industries that already existed in stage 1
and use the term “non-agricultural sector” to denote all the industrialized sectors in stage 2, i.e., the union of the industry sector and
the new processing trade sector.
Note that the effect of this “intermediate good” approach is essentially the same as the direct capital transfer in the baseline
model. However, we choose to include an intermediate good since (1) it is a more precise modeling of the vertical specialization in
the real world; (2) it clearly shows that the production of the intermediate good is still recognized as the output of its original
industry. Thus, the changes induced by offshoring are within the industry rather than compositional, which explains why labor share
trends are explained largely by the within-industry changes rather than between-industry changes (Karabarbounis and Neiman
(2013)). Additionally, this approach highlights the distinctiveness ofthe processing industry and benefits our further analysis.
We assume that the wage paid to these immigrant laborers is a fraction, w, of the marginal productivity of the modern (industry)
sector, ω ≤ 1. If ω = 1, then the processing trade sector and the original industrial sector have the same labor share. On the other
hand,ω < 1 implies that the labor share of the new processing trade sector is weakly lower than that in other industries in China, as
these workers lack bargaining power and are unprotected from labor laws and regulations (see Zhao (1999) and Li, Liu, and Wang
(2009)). This assumption is supported by a number of empirical studies (Koopman, Wang and Wei, 2014). Notably, ω ≤ 1 is sufficient
for most of our results, including the decline in the labor share in the U.S. and China. The only exception is the decline in the labor
share of country 1’s (China's) non-agricultural sector; which requires ω < 1.
In terms of the processing trade, country 2 produces intermediate good itm:
itm = Dk1 − τ (7)
The intermediate good itm is then sold to country 1 at price p. In the processing trade sector of country 1, the intermediate good is
used to produce the final product. We assume that the final output level is Z, and the production function of the processing trade
sector of country 1 is
Z = itmλn1 − λ (8)
The functions of the labor shares change as a result of the emergence of the processing trade sector, and we use Sil′ to denote the
labor share of country i in the second stage:

′ (1 − μ1 ) B1 (L1∗ )1 − μ1 + (1 − α1 ) A1 K1α1 N11 − α1 + ω (1 − α1 )(Z − p∙itm)

S1l =
B1 (L1∗ )1 − μ1 + A1 K1α1 N11 − α1 + (Z − p∙itm) (9)

′ (1 − μ 2 ) B2 (L2∗ )1 − μ2 + (1 − α2 ) A2 (K2 − k )α2 N21 − α2

S2l =
B2 (L2∗ )1 − μ2 + A2 (K2 − k )α2 N21 − α2 + p∙itm (10)
In equilibrium, the price of itm is its marginal output.
p = λ∙itmλ − 1n1 − λ

p∙itm = λZ (11)
Notice that the total payment to capital after offshoring must increase; otherwise, the capital owners have no incentive to go
abroad
α2 A2 (K2 − k )α2 N21 − α2 + p∙itm > α2 A2 K2 α2 N21 − α2 − α2 A2 (K2 − k )α2 N21 − α2 (12)
Now, we compare the two countries' labor shares in the two stages. For country 1, the processing trade sector’ labor share is lower
than the agricultural sector’ labor share and is weakly lower than the industrial sector’ labor share. In the second stage, as the
processing trade sector grows due to labor migration, country 1’s overall labor share decreases.

′ (1 − μ1 ) B1 (L1∗ )1 − μ1 + (1 − α1 ) A1 K1α1 N11 − α1 + ω (1 − α1 )(Z − p∙itm) (1 − μ1 ) B1 (L1∗ )1 − μ1 + (1 − α1 ) A1 K1α1 N11 − α1

S1l = < = S1l
B1 (L1∗ )1 − μ1 + A1 K1α1 N11 − α1 + (Z − p∙itm) B1 (L1∗ )1 − μ1 + A1 K1α1 N11 − α1
(13)
Moreover, if ω < 1, the labor share of the non-agricultural sector of country 1, decreases, let S1, NA denote the labor share of the
l′

non-agricultural (i.e., industrial and processing trade) sector of country 1 in the second stage:

′ (1 − α1 ) A1 K1α1 N11 − α1 + ω (1 − α1 )(Z − p∙itm) (1 − α1 ) A1 K1α1 N11 − α1

S1,l NA = < = 1 − α1 = S1,l NA
A1 K1α1 N11 − α1 + (Z − p∙itm) A1 K1α1 N11 − α1 (14)
For country 2, as the offshore business emerges, the industrial sector of country 2 now focuses on capital-intensive production.
The intermediate goods flow from the industrial sector of country 2 to the processing trade sector of country 1. The total return to
labor in country 2 declines, while the total output may or may not decline, depending on the price of the intermediate good.
Combining these twoeffects, country 2’s overall labor share declines in stage 2; the proof is as follows:

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X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

′ (1 − μ 2 ) B2 (L2∗ )1 − μ2 + (1 − α2 ) A2 (K2 − k )α2 N21 − α2

S2l =
B2 (L2∗ )1 − μ2 + A2 (K2 − k )α2 N21 − α2 + p∙itm

(1 − μ 2 ) B2 (L2∗ )1 − μ2 + (1 − α2 ) A2 (K2 − k )α2 N21 − α2

<
B2 (L2∗ )1 − μ2 + A2 (K2 − k )α2 N21 − α2 + α2 A2 K2α2 N21 − α2 − α2 A2 (K2 − k )α2 N21 − α2

(1 − μ 2 ) B2 (L2∗ )1 − μ2 + (1 − α2 ) A2 K2α2 N21 − α2 − (1 − α2 )[A2 K2α2 N21 − α2 − A2 (K2 − k )α2 N21 − α2 ]

=
B2 (L2∗ )1 − μ2 + A2 K2α2 N21 − α2 − (1 − α2 )[A2 K2α2 N21 − α2 − A2 (K2 − k )α2 N21 − α2 ]

(1 − μ 2 ) B2 (L2∗ )1 − μ2 + (1 − α2 ) A2 K2α2 N21 − α2

<
B2 (L2∗ )1 − μ2 + A2 K2α2 N21 − α2

= S2l (15)
l′
The labor share of the industrial sector of country 2 also decreases, and we use S2, I to denote the labor share of the industrial
sector of country 2 in the second stage (the intermediate steps are similar to (15) and are thus omitted)

′ (1 − α2 ) A2 (K2 − k )α2 N21 − α2 (1 − α2 ) A2 K2α2 N21 − α2

S2,l I = 1 − α
< = S2,l I
A2 (K2 − k )α2 N2 2 + p∙itm A2 K2α2 N21 − α2 (16)

In conclusion, the two-country dual economy model shows that as global industry integration develops (in the form of vertical
specialization), labor share declines occur in both the capital-intensive country and the labor-intensive country. The labor share of the
non-agricultural sector in the capital-intensive country also declines. Finally, if the new workers in the processing trade sector receive
lower salaries than workers in other existing industries (i.e., ω < 1), the labor share of the non-agricultural sector in the labor-
intensive country 1 declines in stage 2.

4. Empirical evidence

In this section, we provide empirical evidence to show that the integration of Chinese labor into the global labor market can also
quantitatively account for the global labor share decline. First, we provide country-level regression results to illustrate the correlation
between labor income share and trade with China. Second, we take an empirical approach similar to Elsby et al. (2013) to show the
relationship between the increasing import exposure and the labor sharedecline among different countries and industries. We also
investigate the impact of the emergence and growth of China's processing trade sector on labor income shares by focusing on the
intermediate good export to China. Our empirical results support our theoretical findings, and confirm and develop the empirical
exercises in Elsby et al. (2013), Autor, Dorn, and Hanson (2013) and Autor et al. (2016).

4.1. Country-level analysis

In our country-level empirical studies, we identify the statistical relationship between country's labor income share and trade with
China. Specifically, the dependent variable is a country's labor income share; the key explanatory variable to test is the country's trade
volume with China (import and export) divided by its GDP, which reflects the depth of its economic connection with China. We also
put in as controls the variables that have been identified as labor share determinants in the literature: relative price of investment,
capital-output ratio, expansion of the financial sector, the degree of economic transitions (measured by industrial composition), share
of labor force in the population, and share of FDI to China in a country's GDP.
The labor share data we use are from the labor share dataset composed by Karabarbounis and Neiman. There are two quantitative
measures of the labor income share in their dataset. The first is the overall labor share, which is aggregate labor income divided by
national income; the second is the corporate labor share, which is the labor income share in the corporate sector. The second
measure, corporate labor share, is more accurate for a couple of statistical reasons (Gollin, (2002), Karabarbounis and Neiman
(2013)); and thus we use it as the main dependent variable in our regression and use overall labor share for comparison.
Our data on China, including the key explanatory variable: the trade volumes, are collected from China's National Bureau of
Statistics (NBS) and China Customs Administration (CCA). CCA began to publish detailed trade data, including data on China's
bilateral trade volume with its trade partners, in 1995.
Our control variables come from multiple sources. We use PWT and WDI price data documented by Karabarbounis and Neiman
(2013) to measure the relative price of investment. In terms of the capital-output ratio, we use the fixed investment share of corporate
output and the capital formation share of total output to represent movements in capital-output ratios. We use the effect of total credit
divided by GDP from the WDI dataset to measure financial development and the share of the agriculture and service sector in total
output to represent industrial transitions. In addition, we use the proportion of the labor force in the total population from the WDI
dataset to measure local labor market conditions and the share of FDI to China in GDP from the WDI dataset to measure connections
to China's labor market. We also controlled the yearly fluctuations through dummies.
Our sample period is from 1995 to 2011, on an annual basis. We choose 52 countries, including both developed and developing
countries, with various economic institutions. 42 out of the 52 countries in our sample experienced labor share decline, and 10
experienced labor share increases. Notably, 7 of the 8 largest economies in our sample experienced labor share decline in our sample

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X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

Table 2
Country-level Regressions to explain cross-country variations in labor share.
Dependent Corporate labor share Overall labor share
variable

Variables (1) (2) (3) (4) (5) (6) (7) (8)

Trade with −0.889*** −0.792*** −0.807*** −0.880*** −0.131** −0.135** −0.114 −0.161**
China/GDP (0.143) (0.132) (0.146) (0.141) (0.0649) (0.0622) (0.0724) (0.0712)
PWT price 0.0449** 0.0395** 0.00487 0.0248***
(0.0182) (0.0178) (0.00895) (0.00920)
WDI price −0.0251 −0.00201 0.0123 0.00561
(0.0152) (0.0142) (0.00941) (0.0104)
Controls Yes Yes Yes Yes Yes Yes Yes Yes
Country fixed Yes Yes Yes Yes Yes Yes Yes Yes
effect
Number of 48 47 50 49 51 50 54 52
countries
Observations 492 502 514 519 518 523 542 539

Note:***p < 0.01, **p < 0.05, *p < 0.1. Same rule applies in the following tables.

period, and the only exception was United Kingdom.

In our baseline regression, we apply fixed effect panel data OLS regression. We estimate an equation of the form:

Sil, t = αi + β1 TCi, t + β2 Pi, t + Xi′, t β3 + εi, t (17)

The dependent variable Si, tl

is country i.s labor income share at time t. TCi, t is the country's relative trade volume with China at
time t. Pi, t is the county's relative price of investment, which is regarded as the main explanatory variable for global labor share
decline by Karabarbounis and Neiman (2013). Xi, t′ includes the control variables (including the dummies). αi is the intercept. β1, β2,
and β3 are the coefficients. εi, t is the residual. Our regression results are listed in Table 2.1
Specifications (1) to (4) show the results using corporate labor share as de-pendent variables; for comparison, specifications (5) to
(8) show the results using overall labor share as dependent variables. We use PWT price as the measure of investment prices in
specifications (1), (3), (5), and (7), and use WDI price in specifications (2), (4), (6), and (8). Also, we use the share of agriculture and
service sectors as the measures of industrial structure in specifications (1), (2), (5), and (6), and use the share of the industrial sector
in specifications (3), (4), (7), and (8).
In all the estimations using corporate labor share as dependent variables, we identify a significant negative impact of trade share
with China on corporate labor shares. Our estimations also show that the relative investment prices measured by PWT prices have a
significant positive effect on labor income share, as predicted by Karabarbounis and Neiman (2013). As for the other control vari-
ables, the results of our estimation are also in line with existing literature. Specifications using overall labor income share as de-
pendent variables show similar but less significant results; this is in line with predictions by Elsby et al. (2013) and Karabarbounis and
Neiman (2013), both highlight the problematic feature of this labor share metric.
Using these estimation results, we also compute the economic significance of China's trade effect. Based on our regression results
and trade data for China, we find that in the 17 years between 1995 and 2011, roughly 1.5% to 1.7% out of the 2.8% global corporate
labor share decline can be explained by the expansion in China's trade, which indicates that roughly 60% of the global labor share
decline in the corporate sector is due to the growth in China's international trade and labor migration in China within the global labor
market.
Despite the statistical significance of the above results, a country level analysis can't capture the structural changes occurred
among and within the industries. These changes play a vital role in supporting our theoretical predictions. In the following section,
we use sector level analysis to provide more detailed empirical results to support our theoretical findings.

4.2. Sector-level analysis

4.2.1. Regression on sectoral import exposure

In this section, we strengthen our empirical result with an estimation of the relationship between country's sectoral trade exposure
and sectoral labor income share. The empirical strategy we employed is closest to Bockerman and Maliranta (2011) and Elsby et al.
(2013). The first examines the mechanism of labor share declines using Finnish manufacturing plant-level data; and the second
studies the connections between import exposures and labor income share of U.S. industries.
We investigate the sectoral labor share and import exposure of our sample countries in 1995–2011. Our sectoral labor income
share data are gathered from the OECD productivity statistics, and our trade data are collected from the UN Comtrade database and
the Structural Analysis (STAN) Databases of OECD. As in Elsby et al. (2013), import exposure is expressed as the percentage increase

1
To test the robustness of our country-level regression, we also use import and export with China divided by GDP as the dependent variable, regress on several sub-
samples, and use instrumented variables constructed based on David, Dorn and Hanson (2013). All these variations reach similar results to our baseline regression.

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X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

in value added needed to satisfy domestic final demand if the country would produce all its imports domestically. We compute the
import exposure of each sector using trade data and countries' annual input-output matrices. We also calculate the import exposure to
China (also called “Chinese import exposure”, “China import”, etc., see Autor, Dorn, and Hanson (2013)), which is first introduced by
Autor, Dorn, and Hanson (2013). Import exposure to China is similarly defined as the percentage increase in value added needed to
satisfy domestic final demand if the country would produce all the goods it imports from China domestically.
The major challenge in data collection is the disparity between labor income share data and import exposure data. On one hand,
the sectoral labor income shares are from OECD Unit Labour Costs Statistics, whose sector classification is derived from the
International Standard Industrial Classification (ISIC Rev. 3). On the other hand, the industrial production and trade data are ca-
tegorized using ISIC Rev. 4. To deal with this disparity, we focus on the sectors that are identical under both methods of classification
and recalculate the industrial production and trade data if necessary to get compatible series. We sort out a sectoral panel sample
composed of 28 countries (24 OECD, 4 non-OECD) in four of the six main sectors classified by ISIC Rev. 3: manufacturing, industry
(including mining and gas), transportation and communications services (including trade), and financial services, from 1995 to 2011.
We use the following model for our sector-level analysis:

Sil, j, t = αi, j + β1 Importi, j, t + Yi′, j, t β2 + εi, j, t (18)

As in Section 4.1, we employ a fixed effect panel regression as our empirical strategy, the difference is that, in this section, the
fixed effects are measured at sector level. Si, j, tl denotes the labor income share of country i's sector j in year t. Importi, j, t denotes the
import exposure of country i's sector j in year t. Yi, j, t′ contains a set of sector specific control variables including initial labor
conditions, sectoral investment prices that might independently affect sectoral labor share, and year dummies. αi, j is the intercept, β1
and β2 are the coefficients; and εi, j, t is the residual.
Our baseline regression results are listed in Table 3.
The first two columns of Table 3 estimate Eq. (18) using the overall import exposure and the import exposure to China re-
spectively. We identify a significant negative impact of the sectoral import exposure to China on the sectoral labor share, but the
impact of the overall trade exposure on sector labor shares is much less significant. The third column of Table 3 uses the overall
import exposure excluding China and, not surprisingly, the result shows no statistical significance.
The above results confirm our theoretical predictions that “Made in China” does matter: it accounts not only for the labor share
decline driven by between-industry changes, but also for the labor share decline driven by within-industry changes. Also, the impact
is not just for the U.S., but for a wide range of countries that have direct trade relationship with China.

4.2.2. Regression on intermediate good export

In this section we focus on the effect of vertical specialization, i.e. firms segment the production process and shift a part of the
production process to foreign countries with comparative advantage in the production of that specified part. According to our
theoretical results, intermediate good export from a capital intensive developed country to a labor intensive developing country
generally implies an offshoring of the labor intensive components of the developed country's supply chain. This facilitates the growth
of the developing country's processing trade sector, and, consequently, the labor shares of both countries decline. Thus, to investigate
the effects of the emergence and growth of China's processing trade on foreign sectoral labor share, we estimate the impact of the
intermediate good export from sector j of country i to China on the labor income share.

Sil, j, t = αi, j + β1 EIi, j, t + Yi′, t β2 + εi, j, t (19)

where EIi, j, t denotes the export of intermediate goods from sector j of country i to China.
We take two different approaches to conduct our estimations. First, we compute the share of intermediate good export to China in
the respective sectoral output, and estimate its direct effect on sectoral labor share. Second, we further formulate this share by the
multiplication of the share of the intermediate good export in the sectoral export to China, and the share of the export to China in the
respective sector output. Through this decomposition, we isolate the effect of the processing trade sector. Due to data availability, we
focus on the manufacturing industry. Our estimation results are present in Table 4, specification (1) takes the first approach and
specification (2) takes the second.
We find a significant negative correlation between a sector’ share of export to China in total output and its labor income share.
The increase of total export to China, on the other hand, failed to explain the movements in sectoral labor shares. That is to say, the

Table 3
Sector-level baseline regressions.
Variables (1) (2) (3)

Import exposure to China −0.138*** (0.0325) −0.285*** (0.0469)

Import exposure −0.000673 (0.00515) 0.0313 (0.00725)
Controls Yes Yes Yes
Country fixed effect Yes Yes Yes
Sectoral fixed effect Yes Yes Yes
Number of countries 28 28 28
Number of industries 4 4 4
Observations 1218 1279 1201

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X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

Table 4
Sector-level regressions using intermediate good variables.
Variables (1) (2)

China processing trade share of output −0.309** (0.130)

China processing trade share of export −0.612** (0.193)
China export share of output 0.043 (0.235)
Controls Yes Yes
Country fixed effect Yes Yes
Number of countries 28 28
Observations 419 419

decomposition of the trade share and the corresponding estimations shows that, unlike other kind of exports, the increase in the
intermediate good export to China is particularly explanatory for the labor share decline.

4.3. Robustness test

In the following section, we provide several empirical exercises to test of the robustness of our estimations. Specifically, we
analyze the effects of China trade exposure in individual sectors. We separately regress the four sectors on their import exposure to
China. Our results are shown in Table 5, specification (1), (3), (5), and (7) uses import exposure to China as the key explanatory
variable and specification (2), (4), (6), and (8) uses total import exposure.
Three of the four investigated sectors show similar results to the baseline regression, suggesting a significant negative impact of
import exposure to China on sectoral labor share, and the only exception is the industry sector. Part of the reason for this result is that
China's relative industry export to our sample countries are much smaller compared with other sectors. Nevertheless, the significant
negative effect of the overall import exposure on the sectoral labor shares, which already strongly supports the trade story we
discussed, is not dismissible.
To analyze the possible changes over a longer interval (1995–2011), we take the approach in Elsby et al. (2013) to investigate the
cross-sector variations in changes of labor share by estimating the following equation:

∆Sil, j = αi, j + β1 ∆Importi, j, t + Zi′, j, t β2 + εi, j, t (20)

ΔSi, j denotes the change of labor share in sector j of country i during the 1995–2011 period. ΔImporti, j, t denotes the change in
l

import exposure to China in the same period. Zi, j, t′ reflects sectoral labor conditions, and changes in relative investment prices. αi, j is
the intercept. β1 and β2 are the coefficients. εi, j, t is the residual. Our estimations on equitation (19) is presented in Table 6.
The results in Table 6 supports our predication of a shock, such as China's labor market integration, on foreign labor shares. The
off-shoring of the labor intensive components of the production has been a major contributor to the global labor share decline, and
the role of China in this process is extremely important.
To better understand the potential welfare losses across the countries (and sectors) yielded by the import exposure to China. We
need to conduct a more micro-based empirical investigation on the economic welfare losses of the affected workers and the associated
capital gains. We plan to work in that direction in our future research.

5. Conclusion

In this paper, we study the impacts of China's labor migration on the global labor income share through trade. Our theoretical
model and empirical analysis show that competition from a cheap Chinese immigration labor force causes the global labor income
share to decline and can explain over 60% of the total decline. We also find the roots of China's massive labor transition from a
historical perspective, which is reflected by an institutional barrier: the hukou system.

Table 5
Sector-level baseline regressions by sectors.
Industry Manufacturing Industry TTC service Financial service

Variables (1) (2) (3) (4) (5) (6) (7) (8)

Import exposure to −0.130*** −1.656 −2.572*** −12.14**

China (0.0344) (1.141) (0.530) (6.060)
Import exposure 0.00391 −0.0558*** 0.0476 −0.461
(0.00562) (0.0185) (0.0899) (0.572)
Controls Yes Yes Yes Yes Yes Yes Yes Yes
Country fixed effect Yes Yes Yes Yes Yes Yes Yes Yes
Number of 28 28 22 22 27 27 19 20
countries
Observations 419 419 333 333 348 348 118 179

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X. Xu et al. China Economic Review xxx (xxxx) xxx–xxx

Table 6
Regressions on cross-sector variation in changes in labor shares, 1995–2011.
Dependent variable Percent change in labor income share, 95–11

Variables (1) (2) (3)

Percentage change in China import exposure, 95–11 −0.542*** (0.132) −0.553*** (0.125)
Percent change in import exposure, 95–11 −0.256 (0.344) −0.032 (0.123)
Controls Yes Yes Yes
Country fixed effect Yes Yes Yes
Sectoral fixed effect Yes Yes Yes
Number of countries 28 28 28
Observations 96 97 97

Our findings have implications for future research and policy making in both developing and developed countries. According to
our analysis, the labor share decline in the last 30 years was caused in large part by the fast growth of international trade with
developing countries. Globalization speeds up this process, and the labor forces in capital-intensive countries face fierce competition
from abroad. Their competitors, the labor forces in labor-intensive countries, do not enjoy all the benefits of being integrated into the
global market, as their wages are much lower than their marginal productivity. Labor market barriers in labor-intensive countries
such as the rural-urban separation in China allow capital owners to have more bargaining power in labor negotiations and obtain the
most benefits from international labor integration. We believe that labor market institutions should be emphasized in future policy
making related to labor market and wealth redistribution.
Our findings also shed new light on future movements in the global labor market and factor shares. According to our findings and
the work of other scholars on the Chinese labor market, labor migration in China will continue even though the total labor force is at
its turning point. In addition, the increase in manufacturing exports in Southeastern Asia and India is fueled by the large amount of
surplus labor in these countries. The engine of global labor market integration might be beginning to shift to these countries and
cause a further global labor share decline.

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