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Factor Substitution And Economic Growth: A Unified Approach

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  • Xue, Jianpo
  • Yip, Chong K.

Abstract

This paper provides a unified approach to characterizing the relation between factor substitution and economic growth in different one-sector growth models (namely, the Solow, Ramsey, and Diamond models). Our main finding is that if better factor substitution raises savings in the steady state, then a higher per capita income results. There are two channels by which factor substitution affects savings: the positive efficiency effect via income and the ambiguous distribution effect via factor income shares. If the efficiency effect dominates, then a higher elasticity of substitution leads to a higher level of per capita steady-state income. In transition, factor substitution affects the rate of convergence both directly and through the equilibrium profit share. The former arises from diminishing marginal productivity of capital whereas the latter reflects its relative scarcity. Depending on the interaction of these effects, the net outcomes are characterized.

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  • Xue, Jianpo & Yip, Chong K., 2012. "Factor Substitution And Economic Growth: A Unified Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 16(04), pages 625-656, September.
  • Handle: RePEc:cup:macdyn:v:16:y:2012:i:04:p:625-656_00
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    1. Galor, Oded & Ryder, Harl E., 1989. "Existence, uniqueness, and stability of equilibrium in an overlapping-generations model with productive capital," Journal of Economic Theory, Elsevier, vol. 49(2), pages 360-375, December.
    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.
    3. Andreas Irmen & Rainer Klump, 2009. "Factor Substitution, Income Distribution and Growth in a Generalized Neoclassical Model," German Economic Review, Verein für Socialpolitik, vol. 10, pages 464-479, November.
    4. Klump, Rainer & Preissler, Harald, 2000. " CES Production Functions and Economic Growth," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(1), pages 41-56, March.
    5. Guo, Jang-Ting & Lansing, Kevin J., 2009. "Capital-labor substitution and equilibrium indeterminacy," Journal of Economic Dynamics and Control, Elsevier, vol. 33(12), pages 1991-2000, December.
    6. Ramanathan, R, 1975. "The Elasticity of Substitution and the Speed of Convergence in Growth Models," Economic Journal, Royal Economic Society, vol. 85(339), pages 612-613, September.
    7. Turnovsky, Stephen J., 2002. "Intertemporal and intratemporal substitution, and the speed of convergence in the neoclassical growth model," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1765-1785, August.
    8. Palivos, Theodore & Karagiannis, Giannis, 2010. "The Elasticity Of Substitution As An Engine Of Growth," Macroeconomic Dynamics, Cambridge University Press, vol. 14(05), pages 617-628, November.
    9. Kaz Miyagiwa & Chris Papageorgiou, 2003. "Elasticity of substitution and growth: normalized CES in the Diamond model," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(1), pages 155-165, January.
    10. Sala-i-Martin, Xavier, 1994. "Cross-sectional regressions and the empirics of economic growth," European Economic Review, Elsevier, vol. 38(3-4), pages 739-747, April.
    11. Rainer Klump, 2001. "Trade, money and employment in intertemporal optimizing models of growth," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 10(4), pages 411-428.
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    Citations

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    Cited by:

    1. Debdulal Mallick, 2012. "The role of capital-labour substitution in economic growth," Indian Growth and Development Review, Emerald Group Publishing, vol. 5(1), pages 89-101, April.
    2. 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.
    3. Xue, Jianpo & Yip, Chong K., 2013. "Aggregate elasticity of substitution and economic growth: A synthesis," Journal of Macroeconomics, Elsevier, vol. 38(PA), pages 60-75.
    4. Manuel A. Gómez, 2016. "Factor substitution is an engine of growth in a model with productive public expenditure," Journal of Economics, Springer, vol. 117(1), pages 37-48, January.
    5. repec:eee:ecolet:v:159:y:2017:i:c:p:180-184 is not listed on IDEAS
    6. Irmen, Andreas, 2011. "Steady-state growth and the elasticity of substitution," Journal of Economic Dynamics and Control, Elsevier, vol. 35(8), pages 1215-1228, August.
    7. Gómez, Manuel A., 2015. "Capital–labor substitution and long-run growth in a model with physical and human capital," Mathematical Social Sciences, Elsevier, vol. 78(C), pages 106-113.
    8. Manuel Gómez, 2014. "Optimal size of the government: the role of the elasticity of substitution," Journal of Economics, Springer, vol. 111(1), pages 29-53, February.
    9. Jianpo Xue & Chong K. Yip, 2015. "Balanced-Budget Rules, Elasticity of Substitution, and Macroeconomic (In)Stability," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 17(2), pages 196-218, April.

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