Foreign Demand Shocks and Changes in Labor Share of Income

【Authors】

TIE Ying & LIU Yiqun

【WorkUnit】

【Abstract】

The labor share of income is a common metric for assessing fairness in primary income distribution. While Kaldor’s stylized facts posit its long-term stability, China has experienced a persistent decline in its labor share since the 1990s. Existing literature primarily attributes this decline to capital deepening and skill-biased technological change. Notably, this period coincides with China’s accelerated opening up following Deng Xiaoping’s “Southern Tour Speech,” which spurred the take-off of its export-oriented economy. The 21st century further marked a critical transition for China’s export sector, as rising labor costs prompted a shift from a labor-abundant “major trading power” to a “trading strength” characterized by sophisticated technology, premium products, and top-tier branding. Technological spillovers from opening up are inextricably linked to firm input restructuring and productivity gains. This paper advances the understanding of China’s declining labor share from the perspective of foreign demand shocks, identifying technological upgrading among exporters as the core mechanism.
Theoretically, we introduced endogenous technology choices, demonstrating that positive foreign demand shocks induce firms to employ more capital-intensive techniques, thereby reducing the labor share. Empirically, benchmark results reveal a significant negative correlation between foreign demand and the labor share within export firms. These findings withstand extensive robustness checks and endogeneity discussions, with external validity extending to macro-level data and more recent samples. Further analysis decomposes the baseline result, showing that foreign demand expansion generates substantial income effects that partially mitigate the decline in the labor share. Specifically, positive foreign demand shocks prompt exporters to increase imports of capital goods, driving gains in Total Factor Productivity （TFP）. We validated this channel through heterogeneity analyses across trade modes, firm ownership, labor cost, and export market competition intensity. The extended analysis finds a process of upgrading and survival-of-the-fittest occurred among exporters in the aftermath of the 2008 Global Financial Crisis. Crucially, behavioral changes among indirect exporters contributed to a gradual convergence in the labor share between exporting and non-exporting firms.
This study contributes to existing literature in two aspects. First, relative to previous studies linking technological upgrading to the labor share decline （while sharing the core mechanism）, this paper traces the logic upstream by incorporating foreign demand shocks as an exogenous driver of firm-level technological upgrading. This expands the theoretical framework and enhances explanatory power in the context of export-led growth. Second, compared to existing research on trade and labor share, this study （i） adopts a demand-side perspective and pinpoints a mechanism more relevant to Chinese firms; （ii） extends the impact of foreign demand shocks to non-exporters, identifying spillover effects. By analyzing indirect exporters’ behavior, it explains the post-2008 convergence in labor shares between exporters and non-exporters.

JEL: F16, D24

【KeyWords】

Foreign Demand Shocks, Technology Upgrading, Labor Share of Income