Estimation of the Elasticity of Substitution

04-08-2022
MAKRO Makroøkonomi Anders Kronborg Christian Kastrup Peter Stephensen

This paper presents a new state-space framework to jointly estimate the capital-labor elasticity of substitution and time-varying factor-augmenting technical change.

Abstract

This paper presents a new state-space framework to jointly estimate the elasticity and factor- augmenting technical change. Technical change is specified as a smooth process that captures a long run trend and persistent shifts during transition periods. In a simulation study, this approach out- performs the widely applied linear and Box-Cox trend assumptions. The framework is subsequently applied to a dataset containing 16 OECD countries. For all countries, the estimated elasticity is significantly below unity. In the long run, technical change is labor-augmenting, but with several persistent shifts during transition periods, in particular in the 90’s and after the financial crisis.