Academic journal article IUP Journal of Applied Economics

Economic Freedom and Labor Income Share in BICS

Academic journal article IUP Journal of Applied Economics

Economic Freedom and Labor Income Share in BICS

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

In the context of the decline in labor share, the substitution between capital and labor has received considerable prominence in some seminary studies like that of Piketty (2014) and Karabarbounis and Neiman (2014). While Piketty (2014) held the rate of growth of capital as the reason behind fall in labor share, the later focused on the decrease in the price of the investment goods. The main conclusion from the studies is that the degree of substitutability between capital and labor exceeds one (Rognlie, 2016). However, from a broader perspective, both these factors get influenced by the prevalent market structure, government involvement in the economic activities, integration with the global economy and regulatory framework of the labor market. So, in short, they portray the type of institutional setup existing within an economy. The movement in these dimensions brings a change in the structure and the sectoral composition of the economy. And that gives rise to the reallocation of the factors of production. Though competitive forces may bring an increase in the productivity levels, the distribution of gains may not be equal. In the case of developing economies, Treeck and Wacker (2017) found that labor share of both self-employed and wage employees has declined since the 1990s, lagging behind total productivity increases, i.e., the gains from increase in productivity do not get passed to the labor in the form of increase in wage share. Moreover, in manufacturing, the decline was mainly witnessed by low-skilled workers only. One of the causes was the sectoral shifts from labor-intensive to capital-intensive sectors. A greater force that affects the structure of the economy through various institutions is the existing political setup (Acemoglu and Robinson, 2015). So, the distribution of the output between the factor inputs depends much upon the institutional structure that shapes the relationship between the different actors or agents of the economy.

To see the effect of market supportive institutions on the labor income share, the current study utilizes the index of economic freedom as a better reflection for market institutions. Taking capitalism in terms of economic freedom, Young and Lawson (2014) in a panel of 93 countries find that labor share is positively associated with capitalism. The degree of marketoriented or market supportive institutions is better to be reflected in terms of the economic freedom available to the individuals to carry out their day-to-day transactions and exchanges. Individuals possess economic freedom when they are free to procure and exchange property (Gwartney et al, 1996). Moreover, the factors like force, fraud and theft do not exist during these transactions. Further, there is no violation of the same rights enjoyed by the others. The common idea in economic parlance is that economies work better when transactions take place without any external intercession. The general belief is that avenues for accelerating economic growth are higher when there is less outward interference. Higher economic freedom promotes private investment along with allocative efficiency (Gwartney et al., 2006) fueling economic growth (Haan and Sturm, 2006; and Hall and Lawson, 2014) and development (Faria and Montesinos, 2009). However, concerning the distribution of benefits from the economic freedom, there is no consensus. Okun (1975) argued that higher levels of economic freedom are associated with higher degree of inequality. The economic freedom depicts the institutional setup that exists within the economy. It shows the extent to which free market transactions are taking place and the degree to which laws and regulations, government presence and societal norms affect the free market exchanges. Molding the institutional setup, any change in economic freedom will affect the returns factor inputs received during the production process.

The study focuses on four countries, namely, Brazil, China, India and South Africa (BICS), considering their importance in the world economy. …

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