Functional income distribution and labor productivity: The capital deepening channel

This paper investigates the relationship between the functional income distribution and labor productivity growth. Using a panel of 26 OECD countries over the period 1970–2019, we first provide further evidence of the positive effect of the wage share on labor productivity growth. We then examine whether this relationship operates primarily through capital deepening and whether it varies across economies with different structural characteristics. Mediation analysis indicates that capital deepening is the main transmission mechanism, accounting for two-thirds to three-quarters of the total effect. Interaction models further reveal that the effect is context-dependent, being stronger in more innovative and developed economies and weaker in highly capital-intensive environments. Overall, the findings suggest that the effect of income distribution on productivity growth operates primarily through changes in the capital-labor ratio, with its strength depending on the structural and technological capabilities that enable economies to translate wage pressure into investment, innovation, and productivity gains.