Identifying the Elasticity of Substitution with Biased Technical Change

50 Pages Posted: 5 Feb 2009

See all articles by Miguel A. Leon-Ledesma

Miguel A. Leon-Ledesma

University of Kent - Department of Economics

Peter McAdam

European Central Bank (ECB)

Alpo Willman

University of Kent - Canterbury Campus

Date Written: January 28, 2009

Abstract

Despite being critical parameters in many economic fields, the received wisdom, in theoretical and empirical literatures, states that joint identification of the elasticity of capital-labor substitution and technical bias is infeasible. This paper challenges that pessimistic interpretation. Putting the new approach of "normalized" production functions at the heart of a Monte Carlo analysis we identify the conditions under which identification is feasible and robust. The key result is that the jointly modeling the production function and first-order conditions is superior to single-equation approaches in terms of robustly capturing production and technical parameters, especially when merged with "normalization". Our results will have fundamental implications for production-function estimation under non-neutral technical change, for understanding the empirical relevance of normalization and the variability underlying past empirical studies.

Keywords: Constant Elasticity of Substitution, Factor-Augmenting Technical Change, Normalization, Factor Income share, Identification, Monte Carlo

JEL Classification: C22, E23, O30, 051

Suggested Citation

Leon-Ledesma, Miguel and McAdam, Peter and Willman, Alpo, Identifying the Elasticity of Substitution with Biased Technical Change (January 28, 2009). ECB Working Paper No. 1001, Available at SSRN: https://ssrn.com/abstract=1318167 or http://dx.doi.org/10.2139/ssrn.1318167

Miguel Leon-Ledesma

University of Kent - Department of Economics ( email )

Keynes College
Kent, CT2 7NP
United Kingdom
00 44 0 1227 823026 (Phone)
00 44 0 1227 827850 (Fax)

HOME PAGE: http://www.ukc.ac.uk/economics/mal/

Peter McAdam (Contact Author)

European Central Bank (ECB) ( email )

Kaiserstrasse 29
Eurotower
D-60311 Frankfurt am Main
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Alpo Willman

University of Kent - Canterbury Campus ( email )

Finland