Branko Milanovic — Bob Solow on rents and decoupling of productivity and wages

What I find interesting here is a “marriage” between a standard neoclassical view of how income shares of capital and labor are determined (because even if they are determined in a kind of a monopolistic competition, this is still handled by the neoclassical production function), and the distribution of the rent that responds only in part to economic, and mostly to political factors. Readers will remember that the latter was an old idea, going back to neo-Ricardians who simply argued that the distribution between w and rcan take place at any point along the w-r frontier: it is entirely politically determined. In Solow’s view, the determination of what share of the rent goes to labor and what to capital is not solely political. It depends also on their relative scarcities (or put it the other way, on "the reserve army of the unemployed"). But political factors do play a role too: power of trade unions, ideology, who controls the government, probably fear or not of a social revolution etc. So, as these political factors have moved in a direction adverse for labor, the division of the pie has become more favorable to capital.

It is a nice story, and I like that it seems realistic in its combination of purely economic analysis with real-world politics. It needs to be obviously, fleshed out. Solow was surprised by lack of empirical knowledge among economists of the price mark-ups in different industries (mark-ups are an indication of the existence of rents). Apparently, it is not much studied empirically. If, as Solow said, we come up with an estimate that (say) 20-30% of national income is rent, then surely political factors can explain why capital's share is up. If our estimate of rent is 2-3% of national income, then this is not a very promising story. So, it is back to the empirics!—a nice theory to test where many a young economist can hope to make a difference and become famous. Perhaps, who knows, as much as Solow has!

Global Inequality
Bob Solow on rents and decoupling of productivity and wages
Branko Milanovic | Visiting Presidential Professor at City University of New York Graduate Center and senior scholar at the Luxembourg Income Study (LIS), and formerly lead economist in the World Bank's research department and senior associate at Carnegie Endowment for International Peace