Substitution and complementarity between capital, skilled and less skilled workers: an analysis at the firm level in the French manufacturing industry

This paper investigates the substitution possibilities in the production function between capital and two labour inputs, skilled and unskilled workers. We estimate a very general system of factor demand at the firm level, using original panel data obtained by merging three different sources. We take into account the existence of adjustment costs as well as the possibility that productivity shocks are persistent, by estimating autoregressive factor demand equations. In order to correct for the endogeneity of regressors with respect to unobserved heterogeneity as well as productivity shocks, we use the Generalized Method of Moments to estimate factor demand equations separately. We then correct for simultaneity biases across equations to estimate the full system. Long run coefficients are computed from the estimated autoregressive equation. Asymptotic Least Squares finally allow us to test the theoretical restrictions imposed on these coefficients by the model.We find that the elasticity of substitution between skill groups is unitary. Capital is also found to be easily substituted to unskilled labour, but weakly if at all to skilled workers.