A theory of the dynamics of factor shares

This paper proposes a theory of the dynamics of factor shares within the context of an equilibrium model of endogenous innovation, growth, and cycles. Our deterministic model rests on two assumptions: (i) production requires two complementary inputs, capital, and labor, and (ii) technical progress is labor-saving and embodied in capital goods. The model’s unique equilibrium path displays recurring growth cycles, each consisting of an adoption and innovation phase, along which factor shares fluctuate within bounds. The interaction between factor prices and opportunities for labor-saving innovations brings about both persistent growth and aggregate oscillations through which it takes place. We provide evidence that the model-implied correlations between factor shares and the other labor market variables are consistent with the data.