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Death to the Cobb-Douglas Production Function? A Quantitative Survey of the Capital-Labor Substitution Elasticity

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  • Sebastian Gechert
  • Tomas Havranek
  • Zuzana Irsova
  • Dominika Ehrenbergerova

Abstract

We show that the large elasticity of substitution between capital and labor estimated in the literature on average, 0.9, can be explained by three factors: publication bias, use of aggregated data, and mission of the first-order condition for capital. The mean elasticity conditional on the absence of publication bias, disaggregated data, and inclusion of information from the first-order condition for capital is 0.3. To obtain this result, we collect 3,186 estimates of the elasticity reported in 121 studies, codify 71 variables that reflect the context in which researchers produce their estimates, and address model uncertainty by Bayesian and frequentist model averaging. We employ nonlinear techniques to correct for publication bias, which is responsible for at least half of the overall reduction in the mean elasticity from 0.9 to 0.3. Our findings also suggest that failure to normalize the production function leads to a substantial upward bias in the estimated elasticity. The weight of evidence accumulated in the empirical literature emphatically rejects the Cobb-Douglas specification.

Suggested Citation

  • Sebastian Gechert & Tomas Havranek & Zuzana Irsova & Dominika Ehrenbergerova, 2019. "Death to the Cobb-Douglas Production Function? A Quantitative Survey of the Capital-Labor Substitution Elasticity," Working Papers 2019/8, Czech National Bank.
  • Handle: RePEc:cnb:wpaper:2019/8
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    More about this item

    Keywords

    Capital; elasticity of substitution; labor; model uncertainty; publication bias;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • O14 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Industrialization; Manufacturing and Service Industries; Choice of Technology

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