Elasticity of Substitution between Capital and Labor and its Applications to Growth and Development
51 Pages Posted: 8 Mar 2005
Date Written: March 4, 2005
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.
Keywords: Demand for Investment, Dynamic Panel Data, Elasticity of Substitution
JEL Classification: D24, D33, E25, O11, O47, O49
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