Business cycle and factor income shares: a VAR sign restrictions approach

The paper first provides a comprehensive literature review of the theories explaining the cyclical interaction between factor shares and economic activity. Secondly, it assesses if empirical evidence supports those theories, overcoming the strong criticalities present in the current empirical literature. To this end, a Bayesian VAR identified with sign restrictions is set up. The results suggest that countercyclical fluctuations in the labor share are mainly driven by the pro-cyclicality of labor productivity - consistent with overhead costs and risk distribution theories - and by the Phillips Curve effects upheld by Goodwin. The model does not support the expansive effect of a capital share rise suggested by Goodwin. In contrast, there is partial evidence favoring the biased technical change theory.