Production Technology Estimates and Balanced Growth

Abstract

Capital-labor substitution and TFP estimates are essential features of many economic models. Such models typically embody a balanced growth path. This often leads researchers to estimate models imposing stringent prior choices on technical change. We demonstrate that estimation of the substitution elasticity and TFP growth can be substantially biased if technical progress is thereby mis-specified. We obtain analytical and simulation results in the context of a model consistent with balanced and near-balanced growth (i.e., departures from balanced growth but broadly stable factor shares). Given this evidence, a Constant Elasticity of Substitution production function system is then estimated for the US economy. Results show that the estimated substitution elasticity tends to be significantly lower using a factor-augmenting specification (well below one). We are also able to reject conventional neutrality forms in favor of general factor augmentation with a non-negligible capital-augmenting component. Our work thus provides insights into production and supply-side estimation in balanced-growth frameworks.

Factor Substitution and Productivity in New Zealand

“…For other industries, and aggregations, OLS estimates from the first‐order conditions for capital and labour are used as in León‐Ledesma et al . () and models minimising the determinant selected. Since profits are included in the capital share data for New Zealand industries, the mark‐up μ is fixed at zero in all specifications…”

“…These differences are discussed in more detail in León‐Ledesma et al . (, ), who show using Monte Carlo that a three‐equation system can identify the true value of σ and the other parameters better than applying ordinary least squares (OLS) estimation of the first‐order conditions or the Kmenta () approximation (a second‐order Taylor expansion of the production function), and that various estimators produce qualitative similar results. This paper uses non‐linear seemingly unrelated regression estimation using Stata's iterative feasible generalized least squares estimator…”

“…León‐Ledesma et al . () also show that estimates of σ will be biased towards 1 if the economy has been near a balanced growth path or neutrality is imposed when technology is in fact factor‐augmenting. A common functional restriction is to assume an exponential growth rate.…”

The impact of R&D on factor-augmenting technical change – an empirical assessment at the sector level

“…His work spurred a revival of aggregate CES production function research and stimulated a discussion on how to reliably and jointly estimate the substitution elasticity and factor-augmenting technology parameters to overcome the identification problem. Analytically, León-Ledesma et al (2015) also showed that imposing Hicks-neutrality leads to biases towards Cobb-Douglas when the true nature of technical progress is factor-augmenting. This followed-up Klump et al (2007), who had contributed to the argument in favor of CES functions by estimating a normalized production function in a supply-side system of the US economy from 1953 to 1998.…”

Unraveling the Skill Premium

“…Subscripts "0" denote the specific normalization points: geometric (arithmetic) averages for non-stationary (stationary) variables. See Klump et al (2012) for a survey, León-Ledesma et al (2015 for a Monte-Carlo analysis and de La Grandville (1989) and Klump and de La Grandville (2000) for seminal contributions. It is straightforward to see that at the point of normalization, t = t 0 ,t = 0 and…”