Decomposing Labor Share Movements in a Small Open Economy: The Case of Korea

Abstract

Small open economies import substantial amounts of materials from abroad, the prices of which are determined in international markets. This paper presents a theoretical model that shows the potential determinants of the labor share in such economies, and, as a case study, decomposes labor share movements in Korea using a structural VAR. The VAR estimates the effect of materials price changes on the labor share as well as the effect of other potential factors. It is found that a rise in materials prices lowers the labor share; the short-run contribution of materials price fluctuations to labor share movements can be quite large whereas their long-run contribution is modest.