The Substitution Elasticity, Factor Shares, Long-Run Growth, and the Low-Frequency Panel Model

70 Pages Posted: 14 Aug 2014

See all articles by Robert S. Chirinko

Robert S. Chirinko

University of Illinois at Chicago, Department of Finance; CESifo (Center for Economic Studies and Ifo Institute)

Debdulal Mallick

Deakin University - Faculty of Business and Law

Date Written: January 1, 2016

Abstract

The value of the elasticity of substitution between labor and capital (σ) is a “crucial” assumption in understanding the secular decline in the labor share of income and long-run growth. This paper develops and implements a new strategy for estimating this crucial parameter by combining a low-pass filter with panel data to identify the low-frequency/longrun relations appropriate to production function estimation. Using spectral analysis, we assess the extent to which our choices of the critical periodicity and window defining the low-pass filter are successful in emphasizing long-run variation. The empirical results are based on the comprehensive panel industry dataset constructed by Dale Jorgenson and his research associates. Our preferred estimate of σ is 0.40. We document that standard estimation methods, which do not filter-out transitory variation, generate downwardly biased estimates. As high frequency variation is introduced into the model variables, σ declines by 40% to 70% relative to the benchmark value. Despite correcting for this bias, our preferred estimate is substantially below the Cobb-Douglas assumption of σ = 1, and thus implies that the secular decline in the labor share of income cannot be explained by secular increases in the capital/income ratio or secular decreases in the relative price of investment or capital taxation.

Keywords: substitution elasticity, labor income share, long-run growth, low-pass filter, production function parameters

JEL Classification: E220, E250, O400, C230

Suggested Citation

Chirinko, Robert S. and Mallick, Debdulal, The Substitution Elasticity, Factor Shares, Long-Run Growth, and the Low-Frequency Panel Model (January 1, 2016). CESifo Working Paper Series No. 4895. Available at SSRN: https://ssrn.com/abstract=2479816

Robert S. Chirinko (Contact Author)

University of Illinois at Chicago, Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

HOME PAGE: http://tigger.uic.edu/~chirinko/

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Debdulal Mallick

Deakin University - Faculty of Business and Law ( email )

Burwood, Victoria 3215
Australia

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