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Abstract

Capital-labor substitution and total factor productivity (TFP) estimates are essential features of growth and income distribution models. In the context of a Monte Carlo exercise embodying balanced and near balanced growth, we demonstrate that the estimation of the substitution elasticity can be substantially biased if the form of technical progress is misspecified. For some parameter values, when factor shares are relatively constant, there could be an inherent bias towards Cobb-Douglas. The implied estimates of TFP growth also yield substantially different results depending on the specification of technical progress. A Constant Elasticity of Substitution production function is then estimated within a “normalized” system approach for the US economy over 1960:1–2004:4. Results show that the estimated substitution elasticity tends to be significantly lower using a factor augmenting specification (well below one). We are able to reject Hicks-, Harrod- and Solow-neutral specifications in favor of general factor augmentation with a non-negligible capital-augmenting component. Finally, we draw some important lessons for production and supply-side estimation. JEL Classification: C15, C32, E23, O33, O51.

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1175.

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Length: 50 pages
Date of creation: Apr 2010
Date of revision:
Handle: RePEc:ecb:ecbwps:20101175

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Related research

Keywords: Constant Elasticity of Substitution; Factor-Augmenting Technical Change; Technical Progress Neutrality; Factor Income share; Balanced Growth.;

Find related papers by JEL classification:

• C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
• C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
• E23 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Production
• O33 - Economic Development, Technological Change, and Growth - - Technological Change; Research and Development; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes
• O51 - Economic Development, Technological Change, and Growth - - Economywide Country Studies - - - U.S.; Canada

This paper has been announced in the following NEP Reports:

• NEP-ALL-2010-05-02 (All new papers)
• NEP-FDG-2010-05-02 (Financial Development & Growth)

References

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1. Susanto Basu & John G. Fernald & Nicholas Oulton & Sylaja Srinivasan, 2003. "The Case of the Missing Productivity Growth: Or, Does Information Technology Explain why Productivity Accelerated in the US but not the UK?," NBER Working Papers 10010, National Bureau of Economic Research, Inc.
2. Klump, Rainer & Saam, Marianne, 2008. "Calibration of normalised CES production functions in dynamic models," Economics Letters, Elsevier, vol. 99(2), pages 256-259, May.
   
   • Klump, Rainer & Saam, Marianne, 2006. "Calibration of normalised CES production functions in dynamic models," ZEW Discussion Papers 06-78, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
3. McAdam, Peter & Hughes Hallett, A J, 1999. " Nonlinearity, Computational Complexity and Macroeconomic Modelling," Journal of Economic Surveys, Wiley Blackwell, vol. 13(5), pages 577-618, December.
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6. Joon Y. Park, 2000. "Bootstrap Unit Root Tests," Econometric Society World Congress 2000 Contributed Papers 1587, Econometric Society.
   
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   • Park, Joon, 2002. "Bootstrap Unit Root Tests," Working Papers 2003-04, Rice University, Department of Economics.
7. Kai Christoffel & Günter Coenen & Anders Warne, 2010. "Forecasting with DSGE models," Working Paper Series 1185, European Central Bank.
8. Daron Acemoglu, 2000. "Technical Change, Inequality, and the Labor Market," NBER Working Papers 7800, National Bureau of Economic Research, Inc.
   
   • Daron Acemoglu, 2002. "Technical Change, Inequality, and the Labor Market," Journal of Economic Literature, American Economic Association, vol. 40(1), pages 7-72, March.
9. Yoosoon Chang & Joon Y. Park, 2003. "A Sieve Bootstrap For The Test Of A Unit Root," Journal of Time Series Analysis, Wiley Blackwell, vol. 24(4), pages 379-400, 07.
10. Klump, Rainer & Preissler, Harald, 2000. " CES Production Functions and Economic Growth," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(1), pages 41-56, March.
11. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
    
    • Athanasios Orphanides, 1998. "Monetary policy evaluation with noisy information," Finance and Economics Discussion Series 1998-50, Board of Governors of the Federal Reserve System (U.S.).
12. Olivier de La Grandville & Rainer Klump, 2000. "Economic Growth and the Elasticity of Substitution: Two Theorems and Some Suggestions," American Economic Review, American Economic Association, vol. 90(1), pages 282-291, March.
13. Robert S. Chirinko, 2002. "Corporate Taxation, Capital Formation, and the Substitution Elasticity between Labor and Capital," CESifo Working Paper Series 707, CESifo Group Munich.
14. Chirinko, Robert S., 2008. "[sigma]: The long and short of it," Journal of Macroeconomics, Elsevier, vol. 30(2), pages 671-686, June.
15. Alpo Willman, 2002. "Euro area production function and potential output: a supply side system approach," Working Paper Series 153, European Central Bank.
16. Thursby, Jerry, 1980. "Alternative CES Estimation Techniques," The Review of Economics and Statistics, MIT Press, vol. 62(2), pages 295-99, May.
17. Diamond, Peter & McFadden, Daniel & Rodriguez, Miguel, 1978. "Measurement of the Elasticity of Factor Substitution and Bias of Technical Change," Histoy of Economic Thought Chapters, in: Fuss, Melvyn & McFadden, Daniel (ed.), Production Economics: A Dual Approach to Theory and Applications, volume 2, chapter 5 McMaster University Archive for the History of Economic Thought.

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Citations

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Cited by:

1. Cristiano Cantore & Paul Levine & Giovanni Melina, 2013. "A Fiscal Stimulus and Jobless Recovery," IMF Working Papers 13/17, International Monetary Fund.
   
   • Cristiano Cantore & Paul Levine & Giovanni Melina, 2011. "A Fiscal Stimulus and Jobless Recovery," School of Economics Discussion Papers 1111, School of Economics, University of Surrey.
2. Peter McAdam & Alpo Willman, 2012. "Technology, Utilization and Inflation: What Drives the New Keynesian Phillips Curve?," School of Economics Discussion Papers 0912, School of Economics, University of Surrey.
   
   • Peter McAdam & Alpo Willman, 2011. "Technology, utilization and inflation: what drives the New Keynesian Phillips Curve?," Working Paper Series 1369, European Central Bank.
3. Miguel A. León-Ledesma & Peter McAdam & Alpo Willman, 2011. "Aggregation, the skill premium, and the two-level production function," Working Paper Series 1400, European Central Bank.
4. Rainer Klump & Peter McAdam & Alpo Willman, 2012. "The Normalized Ces Production Function: Theory And Empirics," Journal of Economic Surveys, Wiley Blackwell, vol. 26(5), pages 769-799, December.
   
   • Rainer Klump & Peter McAdam & Alpo Willman, 2011. "The normalized CES production function - theory and empirics," Working Paper Series 1294, European Central Bank.

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