Odysseas Katsaitis, Ph.D., Economics, The American College of Greece, 6 Gravias St, Aghia Paraskevi, 153 42, Greece
IAES Submission for IAES Conference in Rome
The evolution of the elasticity of substitution between capital and labor over time: A panel analysis
O. Katsaitis
The American College of Greece
katsa@acgmail.gr
The elasticity of substitution between capital and labor is a central parameter in economic theory. Models investigating the sources of economic growth, the determinants of the aggregate distribution of income and the evolution of unemployment have been found to deliver substantially different implications depending on the particular value of the elasticity of substitution. Thus, it is not surprising that soon after the explicit derivation of the Constant Elasticity of Substitution (CES) production function by Arrow et al. (1961), a wealth of articles appeared trying to estimate this elasticity. Cross-sectional studies at the two-digit level tended to find elasticities insignificantly different from one, while time series studies generally provided much lower estimates of the elasticity.
Fifty years later the issue has not been settled. Estimates of the elasticity are quite sensitive to alternative specifications of the estimation framework. Interestingly enough, an issue that has received attention only recently, is the possibility that the elasticity of substitution between capital and labor is shifting over time. It should be noted that Arrow et al (1961) argued that that there is a distinct possibility that the elasticity of substitution might be shifting over time as a result of the process of economic development. Preliminary data analysis using a sample of 16 countries (EU15 plus USA) indicates that this possibility is worth exploring.
JEL classification numbers: C10, O10, O50