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Baumol and the post-industrial trilemma: examining the relationship between productivity, prices and wages

Lewis, Paul and Peng, Fei (2012): Baumol and the post-industrial trilemma: examining the relationship between productivity, prices and wages.

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Abstract

This paper challenges the economic constraints associated with the so-called post-industrial trilemma. Following Iversen’s and Wren’s seminal 1998 paper, it has been widely accepted that differential industry-level productivity increases rule out a solidaristic structure of wages, due to the fact that private services will become priced out of the market. We challenge this assumption both theoretically and empirically. Theoretically, we highlight the questionable assumptions within William Baumol’s 1967 economic model that underpins the trilemma, contrasting it with alternative neoclassical theory and ‘power theories of industries’. Building upon this, we empirically demonstrate that productivity increases have a very small effect upon industry wages. Much more important is the pricing power of an industry, which results from the complex interaction of firms with their physical and institutional environment. Contrary to the trilemma, this suggests that wage increases are not primarily constrained by sectoral productivity increases. More equal paying societies will certainly have a different structure of relative prices for goods and services to unequal ones. Whether they have sufficient demand to ensure high levels of employment in private services depends upon multiple factors that are not fixed but vary by place and over time. We argue that distributional choices over earnings continue to be open to social and political influence with much less rigid economic constraints than have perhaps been assumed.

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