Elasticity of Substitution, Small Enterprises and Economic Growth

27 Pages Posted: 15 Feb 2017

See all articles by Matteo Aquilina

Matteo Aquilina

Bank for International Settlements

Rainer Klump

University of Frankfurt - Economics and Business Administration Area

Carlo Pietrobelli

University Roma Tre, Department of Economics; United Nations University (UNU-MERIT)

Date Written: Novemeber 2014

Abstract

This paper extends the Lucas (1978) model of firm formation by taking into account a normalised CES function in the production process. In a general equilibrium framework it is proved that there is an inverse relation between the value of the elasticity of substitution and average firm size. This relation is also valid, under fairly general assumptions, in steady state.

If interpreted together with the fact richer countries are characterised by a higher elasticity of substitution this result can explain why the recent literature finds a positive association between the importance of SMEs in an economy and its stage of development but seems to fail in finding causality between the two. They have a common origin: a high value of the elasticity of substitution. The paper also provides a first empirical test of the theory proposed using econometric techniques.

Keywords: Average Firm Size, General Equilibrium Models, Neoclassical Growth Models, CES Function

JEL Classification: C65, E13, L11

Suggested Citation

Aquilina, Matteo and Klump, Rainer and Pietrobelli, Carlo, Elasticity of Substitution, Small Enterprises and Economic Growth (Novemeber 2014). Small Business Economics, No. 26, 2006, Available at SSRN: https://ssrn.com/abstract=2841297

Matteo Aquilina (Contact Author)

Bank for International Settlements ( email )

Basel
Switzerland

Rainer Klump

University of Frankfurt - Economics and Business Administration Area ( email )

Schumannstrasse 60
D-60325 Frankfurt am Main
Germany
+49 69 798-22288 (Phone)
+49 69 798-28121 (Fax)

Carlo Pietrobelli

University Roma Tre, Department of Economics ( email )

Via Silvio D'Amico 77
ROMA, 00154
Italy

United Nations University (UNU-MERIT) ( email )

Maastricht
Netherlands

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