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Elasticity of Substitution between Capital and Labor and its applications to growth and development

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  • Samuel de Abreu Pessoa

    ()
    (Graduate School of Economics, Fundacao Getulio Vargas)

  • Silvia Matos Pessoa

    ()
    (Department of Economics, University of Pennsylvania)

  • Rafael Rob

    ()
    (Department of Economics, University of Pennslyvania)

Abstract

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.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 05-012.

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Length: 51 pages
Date of creation: 04 Mar 2005
Date of revision:
Handle: RePEc:pen:papers:05-012

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Keywords: Demand for Investment; Dynamic Panel Data; Elasticity of Substitution;

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  1. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  2. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, vol. 68(1), pages 29-51, July.
  3. Arellano, M, 1987. "Computing Robust Standard Errors for Within-Groups Estimators," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 49(4), pages 431-34, November.
  4. Richard Blundell & Steve Bond, 1995. "Initial conditions and moment restrictions in dynamic panel data models," IFS Working Papers W95/17, Institute for Fiscal Studies.
  5. Bhargava, A & Franzini, L & Narendranathan, W, 1982. "Serial Correlation and the Fixed Effects Model," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 533-49, October.
  6. Barro, R.J. & Mankiw, N.G. & Sala-i-Martin, X., 1992. "Capital Mobility in Neoclassical Models of Growth," Papers 655, Yale - Economic Growth Center.
  7. Richard Blundell & Stephen Bond, 2000. "GMM Estimation with persistent panel data: an application to production functions," Econometric Reviews, Taylor & Francis Journals, vol. 19(3), pages 321-340.
  8. Javier Alvarez & Manuel Arellano, 2003. "The Time Series and Cross-Section Asymptotics of Dynamic Panel Data Estimators," Econometrica, Econometric Society, vol. 71(4), pages 1121-1159, 07.
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Cited by:
  1. Joakim Ruist & Arne Bigsten, 2013. "Wage Effects of Labour Migration with International Capital Mobility," The World Economy, Wiley Blackwell, vol. 36(1), pages 31-47, 01.
  2. Juselius, Mikael, 2008. "Long-run relationships between labor and capital: Indirect evidence on the elasticity of substitution," Journal of Macroeconomics, Elsevier, vol. 30(2), pages 739-756, June.

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