Elasticity of substitution between labor and capital: robust evidence from developed economies

This paper provides estimates of the aggregate elasticity of substitution between labor and capital (σ) in developed economies. Our empirical strategy consists in estimating two- and three-equation supply-side systems which combine a normalized CES production function and first order conditions for factors of production. Using a panel of 12 advanced economies between 1980 and 2006, it is found that capital and labor are gross complements and σ is on average around 0.7. Moreover, we also document net labor-augmenting technical progress. Our main findings remain robust to various assumptions on time-varying factor-augmenting technical change. Furthermore, we replicate the benchmark results with two alternative datasets. To strengthen these findings a systematic evidence of capital-labor substitution is provided at the country level. Although substantial cross-country variation in σ can be found, a wide range of estimates confirms that labor and capital are gross complements and technical change is net labor-augmenting.