Can Capital Deepening Explain the Global Decline in Labor's Share?

Abstract

We estimate that a unitary aggregate elasticity of substitution between capital and labor is economically and statistically consistent with cross-country data – capital deepening cannot explain the global decline in labor’s share. Our methodology derives from inter-steady-state transitions in the Neo-Classical growth model. The elasticity of substitution is identified from the correlation between trends in labor’s share, investment prices, and consumption growth across countries. We show that previous estimates of this elasticity from international data are biased upwards because they omitted a theoretically and empirically important term related to consumption growth.

Keywords: Elasticity of Substitution, Labor Share, Investment Prices

JEL Classification: E21, E22, E25