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Identifying the elasticity of substitution with biased technical change

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Author Info
Miguel A. León-Ledesma () (Department of Economics, Keynes College, University of Kent, Canterbury, Kent CT2 7NP, United Kingdom.)
Peter McAdam () (Research Department, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
Alpo Willman () (Research Department, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)

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Abstract

Despite being critical parameters in many economic fields, the received wisdom, in theoretical and empirical literatures, states that joint identification of the elasticity of capital-labor substitution and technical bias is infeasible. This paper challenges that pessimistic interpretation. Putting the new approach of "normalized" production functions at the heart of a Monte Carlo analysis we identify the conditions under which identification is feasible and robust. The key result is that the jointly modeling the production function and first-order conditions is superior to single-equation approaches in terms of robustly capturing production and technical parameters, especially when merged with "normalization". Our results will have fundamental implications for production-function estimation under non-neutral technical change, for understanding the empirical relevance of normalization and the variability underlying past empirical studies. JEL Classification: C22, E23, O30, 051.

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Paper provided by European Central Bank in its series Working Paper Series with number 1001.

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Length: 48 pages
Date of creation: Jan 2009
Date of revision:
Handle: RePEc:ecb:ecbwps:20091001

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Related research
Keywords: Constant Elasticity of Substitution; Factor-Augmenting Technical Change; Normalization; Factor Income share; Identification; Monte Carlo.;

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