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The IUP Journal of Applied Economics
Economic Freedom and Labor Income Share in BICS
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The process of development in emerging economies like Brazil, India, China and South Africa (BICS) has an important bearing on the structure of the world economy. With the high potential for growth and presence of large labor force, these economies have affected both the labor and goods market of the world. However, despite many structural changes, these economies have also witnessed the trend of decreasing labor share from the 1980s onwards. The continuing decline is a matter of concern for these economies, considering the local employment structure. The present study investigates whether the adoption of more market supportive institutions (defined in terms of economic freedom) is an important factor responsible for the decline in labor income share. The study uses one- and two-way panel fixed effect model on the data from 2000 to 2014 and the results show that increase in economic freedom leads to a decline in the labor share. It suggests that the labor class does not reap the gains possible because of more economic freedom. For individual areas of economic freedom, the results reveal that the decline in the public sector or government share has a negative impact on the laborís share. That means the protection enjoyed by labor regarding job protection and wage increase in the public sector has a positive influence on laborís share in the total value-added. Further, the study finds that both openness and capital-output ratio have a negative impact on labor share. Among the control variables, only the level of democracy has a positive influence on labor share.

 
 
 

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.

 
 
 

Applied Economics Jouranl.