Model Answer
0 min readIntroduction
Economic growth is fundamentally driven by factors like capital accumulation, labor force growth, and technological progress. Technological progress, however, doesn’t impact all sectors or factors of production equally. The nature of this progress – whether it’s capital-intensive or labour-intensive – has significant implications for the distribution of income between labour and capital. This question delves into this relationship, exploring how different types of technological advancements affect real wage rates and real returns to capital, a core concept in neoclassical growth theory. Understanding this dynamic is crucial for formulating effective economic policies aimed at inclusive growth.
Understanding the Core Concepts
Before analyzing the impact, it’s crucial to define key terms:
- Real Wage Rate: The wage rate adjusted for inflation, representing the purchasing power of wages.
- Real Return to Capital: The return on capital investments adjusted for inflation, representing the profitability of capital.
- Capital-Intensive Sector: A sector that relies heavily on capital (machinery, equipment) relative to labor.
- Labour-Intensive Sector: A sector that relies heavily on labor relative to capital.
Technical Progress in a Capital-Intensive Sector
When technical progress occurs in a capital-intensive sector, it means that the productivity of capital increases. This can be visualized using the Solow-Swan model. The increased productivity of capital leads to:
- Increased Demand for Capital: Firms invest in the new, more productive capital, increasing the demand for capital goods.
- Decreased Marginal Product of Labor: As capital becomes relatively cheaper and more efficient, firms substitute capital for labor. This reduces the marginal product of labor (the additional output produced by one more unit of labor).
- Reduced Real Wage Rate: The decrease in the marginal product of labor translates into a lower real wage rate, as firms are willing to pay less for labor.
- Increased Real Return to Capital: The increased productivity of capital leads to higher profits for capital owners, increasing the real return to capital.
Example: The automation of manufacturing processes using robotics (a capital-intensive technology) has led to increased productivity but also to job displacement and wage stagnation for many manufacturing workers in developed countries.
Technical Progress in a Labour-Intensive Sector
Conversely, when technical progress occurs in a labour-intensive sector, the productivity of labor increases. This leads to:
- Increased Demand for Labor: Firms require more skilled and productive labor to operate the new technologies.
- Increased Marginal Product of Labor: The increased productivity of labor raises the marginal product of labor.
- Increased Real Wage Rate: The increase in the marginal product of labor allows firms to pay higher wages, leading to an increase in the real wage rate.
- Decreased Real Return to Capital: As labor becomes relatively cheaper and more productive, firms may substitute labor for capital, reducing the demand for capital and lowering the real return to capital.
Example: Advances in agricultural techniques (like high-yielding varieties of seeds and improved irrigation) that increase labor productivity in farming can lead to higher wages for agricultural workers and potentially lower returns on investment in agricultural machinery.
Factor Substitution and Elasticity
The extent to which real wages and returns to capital change depends on the elasticity of substitution between capital and labor. If capital and labor are easily substitutable (high elasticity), the impact of technological progress on factor incomes will be more pronounced. If they are less substitutable (low elasticity), the impact will be smaller.
The Role of Skill-Biased Technological Change
It’s important to note that technological progress is often “skill-biased,” meaning it increases the demand for skilled labor more than unskilled labor. This can exacerbate income inequality even in labour-intensive sectors, as the benefits of increased productivity accrue primarily to skilled workers.
Table Summarizing the Effects
| Sector | Type of Technical Progress | Real Wage Rate | Real Return to Capital |
|---|---|---|---|
| Capital-Intensive | Increases Capital Productivity | Decreases | Increases |
| Labour-Intensive | Increases Labor Productivity | Increases | Decreases |
Conclusion
In conclusion, the impact of technical progress on factor incomes is contingent upon the sector in which it occurs and the relative intensity of capital and labor. Capital-intensive progress tends to favor capital owners, while labour-intensive progress benefits workers. However, the reality is often more nuanced, with skill-biased technological change and varying degrees of factor substitutability playing crucial roles. Policymakers must consider these dynamics when designing strategies to promote inclusive growth and address income inequality, potentially through investments in education and skills development to ensure that the benefits of technological progress are widely shared.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.