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The increase in the elasticity of substitution between capital and labour: a repeated cross-country investigation

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  • Samuele Ialenti
  • Guido Pialli

Abstract

The economics literature emphasizes the importance of the elasticity of substitution between capital and labour in several economic contexts. However, analyses of the effect of the elasticity of substitution on the direction of technological change are often overlooked. Most assessments of the direction of technological change rely on a Constant Elasticity of Substitution (CES) production framework. This strand of empirical work considers the elasticity of substitution between capital and labour as a deep and fixed parameter. In this article, we show that the change in the elasticity of substitution that has occurred in recent decades might be an alternative source of change of factor income shares in addition to changes in factor-augmenting technological change. We construct a theoretical environment in which the elasticity of substitution is determined endogenously by the capital share and capital intensity. Rolling window estimates and non-linear estimation methods show that the elasticity of substitution in nine OECD economies observed between 1950 and 2017 was not constant and that, in fact, in the latter half of the 1970s, the elasticity of substitution increased, in the presence of labour-augmenting technical change.

Suggested Citation

  • Samuele Ialenti & Guido Pialli, 2024. "The increase in the elasticity of substitution between capital and labour: a repeated cross-country investigation," Economics of Innovation and New Technology, Taylor & Francis Journals, vol. 33(3), pages 380-400, April.
  • Handle: RePEc:taf:ecinnt:v:33:y:2024:i:3:p:380-400
    DOI: 10.1080/10438599.2023.2185779
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    References listed on IDEAS

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    1. Caselli, Francesco, 2005. "Accounting for Cross-Country Income Differences," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 9, pages 679-741, Elsevier.
    2. Perugini, Cristiano & Vecchi, Michela & Venturini, Francesco, 2017. "Globalisation and the decline of the labour share: A microeconomic perspective," Economic Systems, Elsevier, vol. 41(4), pages 524-536.
    3. Peretto, Pietro F. & Seater, John J., 2013. "Factor-eliminating technical change," Journal of Monetary Economics, Elsevier, vol. 60(4), pages 459-473.
    4. Oliver J. Blanchard, 1997. "The Medium Run," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 89-158.
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    Cited by:

    1. Manuel A. Gómez, 2024. "Elasticity of substitution, long‐run growth, and convergence speed: A general framework," International Journal of Economic Theory, The International Society for Economic Theory, vol. 20(3), pages 352-370, September.

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