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Elasticity of Substitution between Capital and Labor and its applications to growth and development

Author

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  • Samuel de Abreu Pessoa

    (Graduate School of Economics, Fundacao Getulio Vargas)

  • Silvia Matos Pessoa

    (Department of Economics, University of Pennsylvania)

  • Rafael Rob

    (Department of Economics, University of Pennslyvania)

Abstract

This paper estimates the elasticity of substitution of an aggregate production function. The estimating equation is derived from the steady state of a neoclassical growth model. The data comes from the PWT in which different countries face different relative prices of the investment good and exhibit different investment-output ratios. Then, taking advantage of this variation we estimate the long-run elasticity of substitution. Using various estimation techniques, we find that the elasticity of substitution is 0.7, which is lower than the elasticity, 1, that is traditionally used in macro-development exercises. We show that this lower elasticity reinforces the power of the neoclassical model to explain income differences across countries as coming from differential distortions.

Suggested Citation

  • Samuel de Abreu Pessoa & Silvia Matos Pessoa & Rafael Rob, 2005. "Elasticity of Substitution between Capital and Labor and its applications to growth and development," PIER Working Paper Archive 05-012, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    • Handle: RePEc:pen:papers:05-012
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Joakim Ruist & Arne Bigsten, 2013. "Wage Effects of Labour Migration with International Capital Mobility," The World Economy, Wiley Blackwell, vol. 36(1), pages 31-47, January.
    2. Elisa Lanzi & Ian Sue Wing, 2010. "Capital Malleability and the Macroeconomic Costs of Climate Policy," Working Papers 2010.19, Fondazione Eni Enrico Mattei.
    3. Jeremy Greenwood & Juan Sanchez & Cheng Wang, 2013. "Quantifying the Impact of Financial Development on Economic Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(1), pages 194-215, January.
    4. Alison Felix, 2007. "The incidence of capital taxation and the magnitude of its burden," Regional Research Working Paper RRWP 07-02, Federal Reserve Bank of Kansas City.
    5. Botero-García, Jesús Alonso, 2012. "Desempleo e informalidad en Colombia : un análisis de equilibrio general computable," Chapters, in: Arango-Thomas, Luis Eduardo & Hamann-Salcedo, Franz Alonso (ed.), El mercado de trabajo en Colombia : hechos, tendencias e instituciones, chapter 19, pages 795-839, Banco de la Republica de Colombia.
    6. Phillips, Kerk L., 2010. "The Dynamic Effects of Changes to Japanese Immigration Policy," MPRA Paper 23673, University Library of Munich, Germany.
    7. Carlo Carraro & Enrica De Cian & Massimo Tavoni, 2012. "Human Capital, Innovation, and Climate Policy: An Integrated Assessment," Working Papers 2012.18, Fondazione Eni Enrico Mattei.
    8. Scott C. Bradford & Kerk L. Phillips, 2021. "Dynamic effects of changes to Japanese immigration policy," Pacific Economic Review, Wiley Blackwell, vol. 26(1), pages 3-22, February.
    9. López, Ramón & Islam, Asif, 2011. "Fiscal spending for economic growth in the presence of imperfect markets," CEPR Discussion Papers 8709, C.E.P.R. Discussion Papers.
    10. Juselius, Mikael, 2008. "Long-run relationships between labor and capital: Indirect evidence on the elasticity of substitution," Journal of Macroeconomics, Elsevier, vol. 30(2), pages 739-756, June.

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    More about this item

    Keywords

    Demand for Investment; Dynamic Panel Data; Elasticity of Substitution;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D33 - Microeconomics - - Distribution - - - Factor Income Distribution
    • E25 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Aggregate Factor Income Distribution

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