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

Author

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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.

Suggested Citation

  • Samuel de Abreu Pessoa & Silvia Matos Pessoa & Rafael Rob, 2005. "Elasticity of Substitution between Capital and Labor and its applications to growth and development," PIER Working Paper Archive 05-012, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  • Handle: RePEc:pen:papers:05-012
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    File URL: http://economics.sas.upenn.edu/system/files/working-papers/05-012.pdf
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    References listed on IDEAS

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    1. 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.
    2. Barro, Robert J & Mankiw, N Gregory & Sala-i-Martin, Xavier, 1995. "Capital Mobility in Neoclassical Models of Growth," American Economic Review, American Economic Association, vol. 85(1), pages 103-115, March.
    3. A. Bhargava & L. Franzini & W. Narendranathan, 2006. "Serial Correlation and the Fixed Effects Model," World Scientific Book Chapters,in: Econometrics, Statistics And Computational Approaches In Food And Health Sciences, chapter 4, pages 61-77 World Scientific Publishing Co. Pte. Ltd..
    4. 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, July.
    5. 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.
    6. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, vol. 87(1), pages 115-143, August.
    7. 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 431-434, November.
    8. Manuel Arellano & Stephen Bond, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 277-297.
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    Cited by:

    1. Carraro, Carlo & De Cian, Enrica & Tavoni, Massimo, 2012. "Human Capital, Innovation, and Climate Policy: An Integrated Assessment," CEPR Discussion Papers 8919, C.E.P.R. Discussion Papers.
    2. 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, January.
    3. Jeremy Greenwood & Juan Sanchez & Cheng Wang, 2013. "Quantifying the Impact of Financial Development on Economic Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(1), pages 194-215, January.
    4. 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.

    More about this item

    Keywords

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

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D33 - Microeconomics - - Distribution - - - Factor Income Distribution
    • E25 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Aggregate Factor Income Distribution

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