2012 Discussion Papers
School of Economics Discussion Paper 12/04
Non-Balanced Growth and Production
Miguel A León-Ledesma, Peter McAdam and Alpo Willman
University of Kent, European Central Bank, University of Surrey
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.
JEL Classification: C15; C32; E23; O33; O51
Keywords: Balanced Growth; Technical Progress Neutrality; Factor Income share; Constant Elasticity of Substitution; Factor-Augmenting Technical Change
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