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Capital/Labor Substitution, Capital Deepening, and FDI

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Empirical studies show that the elasticity of substitution between capital and labor is larger than one in developed countries but smaller in developing countries. This paper develops a production function which allows for this structure in the elasticity of substitution. The case of a falling real interest rate and capital deepening in the developed countries in the presence of FDI flows from the developed to the developing country is analyzed. It is shown that this structure in the elasticity of substitution can be responsible for a U-shaped relationship between the capital intensity of the developed country and the relative capital intensity of the developing country. This carries over to an inverted U-shaped relationship between the capital intensity of the developed country and FDI profitability.

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Paper provided by Universitaet Augsburg, Institute for Economics in its series Discussion Paper Series with number 295.

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Length: pages
Date of creation: Oct 2007
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Handle: RePEc:aug:augsbe:0295

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Keywords: Capital/Labor Substitution; FDI; Capital Deepening;

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Cited by:
  1. Jürgen Antony, 2010. "A class of changing elasticity of substitution production functions," Journal of Economics, Springer, vol. 100(2), pages 165-183, June.

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