Capital Biased Technological Progress: It Doesn't Just Happen

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Wednesday, 26 December 2012 11:12

Paul Krugman has been rightly troubled by the continuing shift of income shares from labor to capital. However the explanation he considers in the form of capital-biased technological progress requires a little more careful examination.

Krugman discusses the case where there is an exogenous change in the nature of technology that makes capital relatively more productive than labor. This leads to more capital being used, driving up its price, and less labor being used, driving down its price (i.e. wages).

This is a relatively straightforward story, but there is a serious problem. Capital is not a well-defined item. Back in the good old days we could have one good models where capital was corn that we had chosen to use as seed rather than eat. However, once we move into the real world, we have to recognize that what counts as a "capital" is a diverse array of items that includes not only physical goods, but also things likes patents.

There is a long literature on the problem of measuring capital. (The Cambridge capital controversy gives some of the flavor.) But, just to make a simple point, we might end up with considerably less "capital" if we shortened, weakened, or eliminated patent protection, especially in areas where it arguably is impeding technological progress (e.g. software and prescription drugs).

For this reason, the fact that we may appear to be seeing capital-biased technological progress should not be viewed as just some unfortunate event in the world that we have to learn to cope with. If we are in fact seeing capital-biased technological progress it is almost certainly the case that it is at least in part the result of policy decisions that could be handled differently.