What causes are responsible for China’s declining labor income share? We investigate this phenomenon in depth from the standpoint of financial constraints. By summarizing the stylized facts of China’s economy, this paper demonstrates that as China’s economy transforms, the financial market’s imperfections lead to more efficient (non-state-owned) enterprises inclined to use corporate savings for the purpose of “crowding out” workers’ remuneration for endogenous financing, resulting in a rising savings rate and a declining share of labor income. On this foundation, we construct a more general theoretical model regarding China’s economic transformation, propose research propositions, and conduct an empirical study utilizing the Chinese Industrial Enterprises Database from 1999 to 2007. The findings show a strong negative relationship between the financial market imperfections and the labor income share, with a 1% increase in financial constraints reducing labor income share by 0.051%. The rise in savings as a result of the financial restrictions works as a mediator variable in this process. Furthermore, our prediction for the path of the labor income share suggests that China’s savings rate would decline after reaching its peak, while the labor income share will bottom out and rebound by the end of the country’s economic transition. This study uses firm-level micro-data to reveal the internal mechanism of financial constraints lowering labor income share, which is a useful supplement to the existing literature. It also provides empirical evidence and policy options for developing countries to reform their financial systems and increase labor income share in the pursuit of sustainable development.
Labor Income Share at the Firm Level: Global Trends