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Factor Substitution And Economic Growth: A Unified Approach

  • Xue, Jianpo
  • Yip, Chong K.

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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Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 16 (2012)
Issue (Month): 04 (September)
Pages: 625-656

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Handle: RePEc:cup:macdyn:v:16:y:2012:i:04:p:625-656_00
Contact details of provider: Postal: Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK
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  1. Ramanathan, R, 1975. "The Elasticity of Substitution and the Speed of Convergence in Growth Models," Economic Journal, Royal Economic Society, vol. 85(339), pages 612-13, September.
  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, 2007. "Factor Substitution, Income Distribution, and Growth in a Generalized Neoclassical Model," Working Papers 0453, University of Heidelberg, Department of Economics, revised Oct 2007.
  4. 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.
  5. 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.
  6. 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.
  7. Chris Papageorgiou & Kaz Miyagiwa, . "Elasticity of Substitution and Growth: Normalized CES in the Diamond Model," Departmental Working Papers 2001-05, Department of Economics, Louisiana State University.
  8. 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.
  9. 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.
  10. 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.
  11. Klump, Rainer & Preissler, Harald, 2000. " CES Production Functions and Economic Growth," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(1), pages 41-56, March.
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