Capital-Labor Substitution, Institutions and Labor Shares

Daniel Berkowitz

No 5981, Working Paper from Department of Economics, University of Pittsburgh

Abstract: In influential studies, Piketty (2014) and Karabarbounis and Neiman (2014) provide related explanations for the growth in economic inequality around the world since the mid-1980s. A driving force in both studies is that it is easy to substitute labor with capital or, in technical terms, the elasticity of substitution between capital and labor exceeds unity. However, in a critique of these studies, Acemoglu and Robinson (2015) argue that political factors that shape the evolution of institutions have had a more profound impact on inequality. We study the relative importance of these channels in Chinese manufacturing where labor shares have recently exhibited sharp declines and the substitution elasticity of capital for labor generally exceeds unity. Our counter-factual analysis indicates that institutional factors that were shaped by political decisions including declining employment protections and product market liberalizationare more important than capital-labor substitution.

Date: 2016-01
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