The Substitution Elasticity, Factor Shares, and the Low-Frequency Panel Model†

The Substitution Elasticity, Factor Shares, and the Low-Frequency Panel Model† AbstractThe value of the elasticity of substitution between labor and capital (σ) is a crucial assumption in understanding the secular decline in the labor share of income. This paper develops and implements a new strategy for estimating this crucial parameter by combining a low-pass filter with panel data to identify the low-frequency/long-run relations appropriate to production function estimation. Standard estimation methods, which do not filter out transitory variation, generate downwardly biased estimates of 40 percent to 70 percent relative to the benchmark value. Despite correcting for this bias, our preferred estimate of 0.40 is substantially below the Cobb-Douglas assumption of σ = 1. (JEL C51, E22, E24, E25, O41) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Macroeconomics American Economic Association

The Substitution Elasticity, Factor Shares, and the Low-Frequency Panel Model†

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Publisher
American Economic Association
Copyright
Copyright © 2017 © American Economic Association
ISSN
1945-7715
D.O.I.
10.1257/mac.20140302
Publisher site
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Abstract

AbstractThe value of the elasticity of substitution between labor and capital (σ) is a crucial assumption in understanding the secular decline in the labor share of income. This paper develops and implements a new strategy for estimating this crucial parameter by combining a low-pass filter with panel data to identify the low-frequency/long-run relations appropriate to production function estimation. Standard estimation methods, which do not filter out transitory variation, generate downwardly biased estimates of 40 percent to 70 percent relative to the benchmark value. Despite correcting for this bias, our preferred estimate of 0.40 is substantially below the Cobb-Douglas assumption of σ = 1. (JEL C51, E22, E24, E25, O41)

Journal

American Economic Journal: MacroeconomicsAmerican Economic Association

Published: Oct 1, 2017

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