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The role of factor substitution in the theory of economic growth and income distribution: Two examples

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  • Turnovsky, Stephen J.

Abstract

While much empirical evidence suggests that the Cobb-Douglas production function may be a reasonable benchmark for aggregate analysis, we argue that the practice, particularly prevalent in contemporary growth theory, of adopting the Cobb-Douglas technology, may lead to misleading implications. Using two examples, we show that key implications of the models are highly sensitive to small deviations of the elasticity of substitution from unity. The first employs the standard neoclassical model and emphasizes the sensitivity of the speed of convergence to small changes in the elasticity of substitution. This in turn has profound consequences for wealth and income distribution. The second deals with foreign aid and highlights how the relative merits of "tied" versus "untied" aid are also very sensitive to the elasticity of substitution.

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  • Turnovsky, Stephen J., 2008. "The role of factor substitution in the theory of economic growth and income distribution: Two examples," Journal of Macroeconomics, Elsevier, vol. 30(2), pages 604-629, June.
    • Handle: RePEc:eee:jmacro:v:30:y:2008:i:2:p:604-629
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    4. Robert S. Chirinko, 2008. "ó: The Long And Short Of It," CESifo Working Paper Series 2234, CESifo.
    5. Litina, Anastasia & Palivos, Theodore, 2010. "The Behavior Of The Saving Rate In The Neoclassical Optimal Growth Model," Macroeconomic Dynamics, Cambridge University Press, vol. 14(4), pages 482-500, September.
    6. Michael Knoblach & Fabian Stöckl, 2020. "What Determines The Elasticity Of Substitution Between Capital And Labor? A Literature Review," Journal of Economic Surveys, Wiley Blackwell, vol. 34(4), pages 847-875, September.
    7. Bazán Navarro, Ciro Eduardo & Benazic Tomé, Renato Mario, 2024. "Qualitative behavior in a fractional order IS-LM-AS macroeconomic model with stability analysis," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 217(C), pages 425-443.
    8. Hosoya, Kei, 2023. "Impact of infectious disease pandemics on individual lifetime consumption: An endogenous time preference approach," Journal of Macroeconomics, Elsevier, vol. 76(C).
    9. Gómez Manuel A., 2010. "Endogenous Growth, Habit Formation and Convergence Speed," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-32, January.
    10. Kemnitz, Alexander & Knoblach, Michael, 2020. "Endogenous sigma-augmenting technological change: An R&D-based approach," CEPIE Working Papers 02/20, Technische Universität Dresden, Center of Public and International Economics (CEPIE).
    11. Manuel A. Gómez, 2020. "Factor substitution, long‐run growth, and speed of convergence in the one‐sector convex endogenous‐growth model," Metroeconomica, Wiley Blackwell, vol. 71(1), pages 2-21, February.
    12. Mallick, Debdulal, 2010. "Capital-labor substitution and balanced growth," Journal of Macroeconomics, Elsevier, vol. 32(4), pages 1131-1142, December.

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