The role of the elasticity of substitution in economic growth: A cross-country investigation |
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| Authors: | Debdulal Mallick |
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| Affiliation: | 1. International School of Economics and Management, Capital University of Economics and Business, Beijing 100070, PR China;2. Department of Agricultural Economics and Rural Sociology, Auburn University, Auburn, AL 36849, USA;3. Center for Economic Research, Shandong University, Jinan 250100, PR China;1. Department of Marketing and Logistics Management, Chung Chou Institute of Technology, Changhua 51003, Taiwan;2. Department of Applied Economics, National Chung Hsing University, Taichung 40227, Taiwan;3. Bachelor''s Degree Program of Hotel Management, Tainan University of Technology, Tainan 71002, Taiwan;1. University of Turku, School of Economics, Department of Economics, Rehtorinpellonkatu 3, FIN-20500 Turku, Finland;2. National Land Survey of Finland, Finland;3. Aalto University, Finland;1. Economic Analysis Department, Facultad de CC. Económicas y Empresariales, University of Seville, Ramon y Cajal 1, 41018 Seville, Spain;2. Economic Analysis Department, Facultad de CC. Económicas y Empresariales, University of Seville, Ramon y Cajal 1, 41018 Seville, Spain |
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| Abstract: | Although the importance of the elasticity of substitution between capital and labor (σ) has long been recognized in several branches of economics, it has not received enough attention in the growth literature. de La Grandville (1989) showed theoretically that at any stage of an economy's development, the growth rate of income per capita is increasing with σ. The higher is σ, the greater the similarity between capital and labor in the production function, and thus diminishing returns set in very slowly. To the best of our knowledge, this is the first paper that tests the hypothesis that growth rate is increasing with the value of σ at the cross-country level. We estimate σ for 90 countries from direct estimation of the normalized CES production function and then include these estimators as an explanatory variable in cross-country growth regression. We investigate the sign and significance of the coefficient of σ conditioning on country characteristics, initial conditions, and a set of policy variables. After accounting for endogeneity and the fact that σ is a “generated” regressor, we find strong support for the hypothesis. The result is robust to both Leamer's (1983) extreme value analysis and Bayesian model averaging. About a fifth to a quarter of the growth rate differential between East Asia and Sub-Saharan Africa can be explained by σ alone. |
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